For the past several months, my life has been consumed with my health. I was informed in June that I would probably need surgery on my leg for an injury I incurred in May. An MRI confirmed that result in late August. I received a cortisone shot and was able to schedule my surgery in December to align with the school winter break. This has been a lot, physically, to handle. But healthcare and finance are very much intertwined, and one of my favorite financial tools is the health care account I have through work called the FSA (Flexible Spending Account). Other people will have access to a similar account called the HSA (Health Savings Account). Both are tax-advantaged accounts for paying for most things medical and I think everyone should have one if they can.
I have been very fortunate to always have health insurance. Strike that, great health insurance. My parents both worked union jobs and I work a union job now. I have never been without insurance coverage. As such, I never knew much about health insurance or paying for medical care until this past year when I knew I’d be looking at several on-going expenses even with my good health insurance. I learned from a friend at work that our employer offers an FSA which is a separate account one can use to pay for out-of-pocket medical care. I was able to learn about this in time to establish one during the November open enrollment period and it became available to me January 1, shortly after my surgery.
Even with good health insurance, everyone has some medical care costs throughout the year. Back when I started my job, we sat in a presentation during which we were basically told not to bother with an FSA because if you don’t spend the money, it will disappear. The presenter in essence told us the FSA was not worth it. This was about the worst financial advice anyone has ever given me.
Double Tax Advantage of Health Accounts
Let’s take a step back and determine how an FSA or an HSA benefit you in your daily life. These are accounts set up through your employer to help you pay for health care. They are awesome because they use pre-tax dollars. What this means for you: say you have a $20 prescription cost. Just paying for it, how I did for years, from your checking account, means you pay with after tax dollars. That means I’d need to earn $23.25 at work to be able to have $20 to spend from my checking account. This is because I have about a 14% effective tax rate (all of my local, state, federal, and Medicare taxes divided by my gross income). If you have a higher effective tax rate, like 25%, you’d need to earn $26.66 at work to be able to pay for that $20 prescription. If you use your health account, you only need to earn $20 at work to pay that $20 bill. You might be thinking 3 bucks, 6 bucks, who cares? Well, first off, that’s just nonsense. Any money you save, even a dollar, is a benefit to you. But expand this out to a year: say you pay $20 a month for a prescription, that’s $240 for a year. You could pay with a health account exactly $240 from your gross income, or you could pay with after tax dollars, requiring you to earn $279.07 if you have my 14% tax rate. Now you just saved yourself almost 40 bucks on just that prescription alone. That’s just one example.
The health accounts can be used to pay for prescriptions, contacts, and office visit co-pays. These are the top three expenses they help with, in my opinion, but check your HR guide for the extensive list of every expense you can use the account on. If you’re like me and visit the doctor all the time, co-pays can add up. Every time I go to the physical therapist, I have to pay $15. To visit the surgeon, it’s $25. I know people have co-pays ranging from $10 to $30, and these have to be paid for each visit no matter how many times you visit them. Everyone has some medical costs throughout the year and being able to use pre-tax dollars in one of the health accounts is an invaluable financial tool.
In an earlier article, I showed how contributing to a 401(k), IRA, or 457 account can lower your tax liability. The FSA/HSA do the same thing. But the health accounts can be used today to pay for your daily medical expenses. Say you contribute $500 to your health account, that means your taxable income will be lowered by $500. If you’re in the 12% tax bracket, that means you lower your federal tax bill by about $60. My Ohio state tax bill would go down about $15. This is the double benefit of the health accounts. First, you get to pay for your medical expenses with pre-tax money. Second, you get to pay less in taxes. For me, $500 in that account first saves me $81.39: if I had to pay $500 in after tax dollars, I’d need to earn $581.39 to get $500 deposited in my checking account. Then, $500 comes off my taxable income taking me from about $40,665 to $40,165, which saves me $60 in federal taxes and $15 in state taxes. I’ll take that total of $156.39 in savings!
FSA vs. HSA – Contributions and Rollover Limits
You are able to contribute more to the health accounts to further lower your taxable income, but that is where the difference between the FSA and HSA become very important. Let’s revisit what that presenter told me during my first week as a fully employed adult: don’t do an FSA because you can lose the money. This is 100% true. If you do not spend the money you contribute to an FSA throughout the year, it will disappear, not roll over. Contributions to an HSA roll over from year to year. You need to know if you have an FSA or an HSA so you can determine your contributions. In some cases, $500 of an FSA will roll over, but check with your HR department to know if you have that option.
- While the maximum you can contribute to an FSA in 2018 is $2650, you don’t want contribute that much if you aren’t certain you’ll spend all of it. I looked at my co-pay costs from past years and asked my doctors how many visits I should expect post-op and figured $550 to be an appropriate level to contribute. If I don’t spend it all on post-surgery care, I know I can use the account to buy contact lenses, which I do wear regularly.
- The maximum you can contribute to an HSA in 2018 is $3450 and if you can, you should contribute the maximum, since it rolls over. This allows you to save for potential future health costs, whether unforeseen emergencies or you just want to save for potential costs that come with age.
FSA vs. HSA – Type of Health Insurance Coverage
The biggest difference determining which account you’ll have access to is what type of health insurance you have. The HSA is only available to people enrolled in a HDHP (High Deductible Health Plan). The IRS defines high deductible as $1350 or more for a single person or $2700 for a family. This means that if you are required to pay $1350 before your insurance starts to pay for your health care, then you can have an HSA. The HSA allows you to pay your deductible with pre-tax dollars. High deductible plans, in theory, mean a lower premium (the amount you pay every month just for having health insurance). You are able to contribute 2.5 times the deductible. You’d probably want to contribute at least the amount of your deductible to the account so you have it ready to go if you need to pay it.
An FSA can be offered to people with other insurance – the not high deductible plans. My deductible is $0. We just have to pay co-pays for most office visits.
Additional Benefit of the HSA
There is a third tax advantage of the HSA. An HSA is very similar to a 401(k) retirement account because you can actually invest the money and it will collect interest. You will not have to pay tax on the growth your HSA account accumulates. While you are young and in your 20s it would be an excellent idea to invest your HSA money in stocks that will grow a lot, so that you have even more money available to you when you reach an age when you’ll pay more for health care.
This option isn’t available for an FSA because it doesn’t have the yearly roll over.
Always have an FSA or HSA
Even in future years when I won’t be paying for weekly office visits and regular prescriptions, I plan to always contribute a little bit to my FSA since it is a double tax advantage. Contact lenses alone can cost $200. I’ll probably maintain $200 to $500 in contributions in future years. I also like the psychological support the FSA gives since I have a completely separate account for medical expenses. I don’t have to think about whether paying for my co-pay means less fun spending that month. The money is already set aside and accounted for. There really is no reason not to hold one of these health accounts if you have the opportunity for it. If you have children, these accounts are going to be gold-mines since kiddos always have to go the doctor.
We never know how health care cost and insurance coverage is going to change given it is heavily tied to our political climate. The best thing you can do for your personal situation is just be prepared and use the tools available to you. That’s why if you have access to the HSA, you should build up the account for your own personal insurance plan and make it ready for a long time horizon. They don’t expire so you can have hundreds of thousands of dollars in your 50s when costs start to rise.