Selecting a health insurance plan is often anxiety-producing for many people because of the myriad of choices that need to be made.
- Do I want a high-deductible or low-deductible plan?
- HMO or PPO?
- A plan with my primary care physician in the insurance carrier’s network, or a plan I like more that my doctor doesn’t participate in?
To add to the confusion, another decision that sometimes needs to be made is whether or not to select a Health Savings Account (HSA) or a Flexible Spending Account (FSA). Let’s look carefully at the two types of accounts and determine which is the best choice for your situation.
HSA’s were introduced in 2004 as part of the Medicare Prescription Drug Improvement and Modernization Act, which was signed into law by President George W. Bush. The law allows individuals covered by a high-deductible health insurance plan (HDHP) to save on eligible expenses through their HSA.
An HDHP is defined as any plan with a deductible of at least $1,350 for an individual or $2,700 for a family. These plans are usually selected by individuals or families concerned with having large medical expenses covered, such as hospital stays or surgery, rather than smaller expenses, such as routine office visits. They are sometimes referred to as “major medical plans.”
One of the most important features of an HSA is that the money you contribute to it can be rolled over from year to year, making it a useful savings tool. Some HSA’s allow you to invest the money, which many financial advisors caution against because the funds may not be there when you need them if your investment choices have decreased in value.
Another important feature of HSA’s is that contributions to the account are made with “pre-tax dollars.” This reduces the taxable gross amount of your paycheck, resulting in a lower income tax liability. The IRS rewards you, in effect, for setting money aside for medical expenses.
With an HSA, you own the account, not your employer. This means that if you leave your employer, you can take your HSA with you. This is important because it’s entirely possible to accumulate a substantial amount of money in your HSA because of the ability to carry over unused funds from year to year. Annual contribution limits are up to $3,450 for an individual and $6,900 per household.
Contributions to an HSA can be taken out of the account tax-free after age 65. If they’re used before age 65 for non-medical expenses, they’re subject to a 20% penalty and must be declared on your income tax return.
In the 1970s, the IRS created the Flexible Spending Account (FSA) to allow employees to pay pre-tax dollars for medical expenses and dependent care expenses that are not covered by their employer-sponsored health plan. With a medical FSA, employees advise their employer that they wish to forego a certain amount of their taxable gross paycheck (up to $2,650 per year for an individual, $5,300 per household). This is done in return for an equivalent-sized non-taxable FSA annual allowance to pay for out-of-pocket qualified medical expenses.
The FSA and HSA are two very different types of accounts with one significant similarity: both allow you to contribute on a pre-tax basis. As previously mentioned, this reduces your taxable gross income and lessens your tax liability per paycheck.
However, there are many differences between the two types of accounts. One significant difference is that any money you contribute to your FSA in a given year must be used that year, or the funds are forfeited to the employer. There are two other rollover options the employer can choose, however. They are:
- Employees get a grace period of 2 ½ months to use the funds
- Employees can roll over $500 into next year’s FSA
With an FSA, the employer owns the account, and it is lost with a job change unless you’re eligible for continuation through COBRA. This could lead to a substantial forfeiture if you were to leave your employer late in the year with a large portion of your annual contribution sitting unused in the account.
Contribution amounts to an FSA can be changed during open enrollment, if your family situation changes, or if you change your health plan. With an HSA, contribution amounts can be adjusted at any time as long as the contribution limits aren’t exceeded.
The most significant determinant for which type of plan, FSA or HSA, is better for you is the type of health plan you have. If you have a high-deductible health plan, you will have to enroll in an HSA. If you have an HMO or PPO at work with a low-deductible, you’ll have to enroll in the company-sponsored FSA. If you’re self-employed, you can enroll in an HSA if you have an HDHP, but there is not an FSA option available to the self-employed. Your health plan will determine which type of plan is better for your health insurance needs.
With both plans, you need to consider that they have limitations, mainly their contribution limits. Because you can only contribute so much money in any given year, you could have a shortfall with major medical expenses depending on usage. For this reason, a critical illness insurance policy is a prudent choice, especially if you have a high-deductible health insurance plan. These policies will pay you a lump-sum directly if you have medical expenses related to certain health conditions, particularly:
- Heart Attack
- Coronary artery bypass surgery
- Invasive cancer
- Non-invasive cancer
- Kidney (renal) failure
- Major Organ Transplant
- Advanced Alzheimer’s disease
Another essential type of coverage to have is disability insurance, which is designed to protect your income if you become sick or injured and can’t perform the duties of your occupation. An FSA or HSA account can help you with medical expenses, but they can’t make up for lost income needed to pay your living expenses and other financial obligations. A professional, licensed insurance agent can help you determine the best coverage options for your situation.
Jack Wolstenholm is the head of content at Breeze.
The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.