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Things to Know About HSA & FSA

Funding medical care is an important issue and many people assume that paying out of pocket or filing on health insurance are the only options. However, alternatives do exist and it is important to understand what each entails before making a selection. Two of these models are the health savings account (HSA) and the flexible spending account (FSA).

  1. Flexible Spending Accounts

    • A flexible spending account (FSA) is an arrangement in which an employer deducts a regular payment from the employee's paycheck. This sum is deposited into an account and is available to be spent on authorized medical needs. The advantage to an FSA is that this deduction from the employee's pay is made before taxes. This provides the benefit of reducing the employee's taxable income. The amount set aside each pay period is determined by the employee, though individual employers may have parameters restricting the amount. Qualified medical expenses follow the guidelines established by the Internal Revenue Service, though these are quite broad, including not only fees for medical services, but also over-the-counter items like bandages, antacids and many other items that may be purchased at a local drugstore. A key criticism of the FSA model is the "use it or lose it" aspect. Any funds deposited into the FSA that are not used are lost at the end of the year.

    Health Savings Accounts

    • Health savings accounts more effectively address some of the problems inherent in FSAs. HSAs deduct pretax money from employees' compensation in a manner similar to FSAs. However, these funds persist beyond the calendar year in which they were deposited. This aspect encourages investment of greater sums into the account, providing for future medical expenses while reducing the employee's tax burden. By law, employees cannot participate in an HSA unless they have health insurance coverage under a high deductible health plan. Both the FSA and HSA were designed to help control medical costs by placing some of the burden of payment on those receiving care. Theoretically, this mitigates the instance of unnecessary procedures while protecting against the economic damage of catastrophic illness.

    Other Considerations

    • Before selecting either of these options, you should consider the degree of coverage and expense of available health plans. Personal medical history, family medical history and financial situation--both current and (likely) future--are all elements that should be weighed in the decision. Because funds deposited in either of these accounts will not be accessible, careful planning is required in determining the amounts to deposit. Also note that IRS rules allow deduction of out-of-pocket medical expenses if they exceed 7.5 percent of the taxpayer's income for the year in which they are incurred. This means that significant medical expenses will reduce your taxable income in the same manner as participation in an FSA or HSA.

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