The Difference Between A Flexible Spending Account And A Health Savings Account
A Flexible Spending Account is an employee benefit that allows you to set aside money, on a pre-tax basis, for certain health care and dependent care expenses. There are three types of FSA accounts: 1) Health Care FSA 2) Limited Expense Health Care FSA and 3) Dependent Care FSA . If you make an FSA election for the 2022 plan year during the current Federal Benefits Open Season , your election amount will be divided into allotments based on the number of pay dates in the plan year. Every pay date, an allotment is deposited directly into your FSA.
You cannot have both a HCFSA and an HSA. For additional information, view the comparison chart on the OPM website.
Don’t Spend Your Contributions
This may sound counterintuitive, but we’re looking at an HSA primarily as an investment tool. Granted, the basic idea behind an HSA is to give people with a high-deductible health plan a tax break to make their out-of-pocket medical expenses more manageable.
But that triple tax advantage means that the best way to use an HSA is to treat it as an investment tool that will improve your financial picture in retirement. And the best way to do that is to never spend your HSA contributions during your working years and pay cash out of pocket for your medical bills.
In other words, think of your HSA contributions the same way you think of your contributions to any other retirement account: untouchable until you retire. Remember, the IRS does not require you to take distributions from your HSA in any year, before or during retirement.
If you absolutely must spend some of your contributions before retirement, be sure to spend them on qualified medical expenses. These distributions are not taxable. If you are forced to spend the money on anything else before youre 65, you will pay a 20% penalty and you will also pay income tax on those funds.
Limited Time Fsa Special Opportunities
The grace period for spending 2020 FSA accounts is extended to December 15, 2021 and the deadline to reimburse yourself and submit receipts is extended December 31 due to a federal relief opportunity passed in response to COVID-19. The same is true next yearspend 2021 dollars until December 2022. These dates are extended from the upcoming March deadlines you may be accustomed to.
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Reimburse Yourself For Expenses
With an HSA you are not required to take a distribution to reimburse yourself in the same year you incur a particular medical expense. The key limitation is that you cant use an HSA balance to reimburse yourself for medical expenses you incurred before you established the account.
So keep your receipts for all healthcare expenses you pay out of pocket after you establish your HSA. If in your later years, you find yourself with more money in your HSA than you know what to do with, you can use your HSA balance to reimburse yourself for those earlier expenses.
How Should I Keep Track Of My Eligible Expenses
You should keep all your receipts and pertinent documentation to prove your Health Care FSA was used for eligible medical expenses. If you pay for anything other than eligible expenses with your Health Care FSA, the amount will be taxable, and you will be required to repay the amount or pay an additional tax penalty.
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Dependent Care Reimbursement Account
Expenses incurred for dependent care services that allow you and your spouse to work are eligible for reimbursement under the Dependent Care Reimbursement Account. Eligible expenses for your child , disabled spouse, or other disabled dependent include the cost of daycare centers, private babysitters, and nursery schools.
The Dependent Care Reimbursement Account differs from the Medical Care Reimbursement Account in that, in the Dependent Care Reimbursement Account, you must have funds deposited before you can be reimbursed for expenses. The maximum limit is $5,000 per household.
Stay Within A Safe Spending Range
Another way to look at flexible spending rules in retirement is to do away with a specific withdrawal percentage altogether. Instead, you may choose a percentage range that you stay within.
Kitces gives the example of 3% to 5%. If you chose that as your range, youd be good to go as long as your spending stayed within that channel.
If youre spending drops below 3% of your portfolio value, you get a 10% raise. And if youre spending rises above 5%, then youd have to take a pay cut of 5%.
Using this strategy, you could begin with a 4% withdrawal rate instead of 3.5% if you wanted. So, beginning with a $1 million starting balance, you could withdraw $40,000 in Year 1 as opposed to $35,000.
But if your portfolio fell below $800,000, youd have to take a 5% pay cut. On the flip side, if your portfolio grew to 1.35 million, youd get a 10% raise.
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Hsa Vs Fsa Eligible Expenses
HSAs and FSAs have similar rules regarding which medical expenses you can pay for with your contributed funds. For example, you can pay for prescription medications, eye care, hearing aids, most types of dental care, chiropractic care, and most other medical services.
However, dependent-care FSAs enable you to pay for many things HSAs do not. For example, you can pay for child care costs including day care, overnight summer camp, housekeeping expenses related to dependent care, and similar expenses incurred while caring for qualifying dependents.
Whats The Benefit Of An Fsa
- Gives you peace-of-mind. With the money set aside, youll be ready for large health-related costs such as new prescription glasses, or for your weekly daycare costs.
- Easy to use. Youll receive a debit card for your health care FSA. Its as easy to use as the bankcard you use every day. Or you can submit your health and dependent daycare claims online or by using a phone app.
- Saves money on taxes. A FSA saves you money by lowering the taxes deducted from your paycheck. Because your FSA contributions are taken out before taxes are considered, you lower your income and your tax payments too. FSA users save about 30 cents for every dollar deposited into their FSA, depending on their tax bracket.
Heres an example that shows the tax savings:
|Savings with an FSA||—|
* Sample tax savings for a single taxpayer with no dependents. Actual savings will vary based on your individual tax situation. Please consult a tax professional for more information.
- Find your potential savings. Use the personalized FSA calculator help you crunch the numbers to determine the amount of money to set aside from each paycheck and the amount of savings youll get back in return.
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Warnings About Hsa Retirement Use
The strategies described in this article are based on federal tax law. Most states follow federal tax law when it comes to HSAs, but yours may not. As of the 2020 tax year, California taxes HSA contributions. Even if you live in a state that taxes HSAs, however, youll still get the federal tax benefits.
The taxation of these plans could change in the future at either the state or federal levels. The plans could even be eliminated altogether, but if that happens, we would likely see the existing account holders exempted, as was the case with Archer MSAs.
Understanding Your Flexible Spending Account
Both a Health Care Flexible Spending Account and a Dependent Care FSA may be available to benefit-eligible faculty and staff depending on your medical enrollment choices. Retirees are not eligible for an FSA.
You do not need to enroll in a medical plan to be eligible for a Health Care FSA however, you cannot enroll if you currently participate in a Health Savings Account . Any benefit-eligible employee can enroll in the Dependent Care FSA regardless of medical plan enrollment.
ASIFlex administers both kinds of FSA visit our plan contacts page for provider information.
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What Are The Key Differences Between An Hsa Vs Fsa
Both a health savings account and a flexible spending account allow you to pay for medical care with pre-tax dollars, which reduces the cost. With healthcare accounting for 8.1% of Americans’ average monthly expenses, these tax shelters are important financial tools.
But while an HSA and FSA sound similar, there are important differences between them.
- HSAs are tax-advantaged accounts either you or an employer can open and contribute to if you have a qualifying high-deductible health plan . HSAs allow you to make pre-tax contributions and take tax-free withdrawals to pay for covered care. The money in an HSA can be invested and grow over time and can also be withdrawn after 65 and will be taxed at your ordinary tax rate with no penalties.
- You can also make pre-tax contributions and take tax-free withdrawals from FSAs, but they can only be opened by employers. These accounts serve as a short-term savings account rather than an investment account. You must decide at the start of the year how much to contribute, the money cannot be invested, and it is lost if not used for medical care in the year it is contributed or shortly thereafter.
HSAs provide much more flexibility on how you spend your money, while FSAs allow you to pay for both medical care and dependent care with pre-tax dollars. This guide will help you understand how the rules differ when it comes to eligibility, using account funds, and more.
What Is A Health Savings Account
HSAs are tax-advantaged savings accounts designed to help people who have high-deductible health plans pay for out-of-pocket medical expenses. While these accounts have been available since 2004, many eligible Americans are not taking advantage of them.
These types of high-deductible health plans are offered by about 26% of employers who offer health benefits as of 2020. According to a March 2019 report from the Employee Benefit Research Institute , anywhere from 21.8 million to 36.8 million people had HSA-eligible health insurance plans in 2018, but only 11%-22% of those individuals had actually opened an account.
Moreover, people with HSAs had an average balance of just $3,221 in 2019a pittance, considering that the allowable annual contribution in 2021 is $3,600 for those with individual health plans and $7,200 for those with family coverage .
In addition, only 7% of HSAs were in investment accounts other than cash, as of 2019. EBRI found that virtually no one contributes the maximum, and nearly everyone takes current distributions to pay for medical expenses.
All of this means that consumers who have HSAsas well as consumers who are eligible for HSAs but havent opened oneare missing out on an incredible option for funding their later years. Its time to start a new trend.
Hsa Vs Fsa Comparison Chart
The chart below provides insight into the key differences between HSAs and FSAs so you can learn the rules for each account.
For many people, an HSA offers more flexibility and is a better choice. However, if you do not have a qualifying HDHP and so aren’t eligible for an HSA, and your employer does offer an FSA, it may be your best option for paying for healthcare expenses with pre-tax dollars.
Is A Flexible Spending Account Worth It
For one thing, $2,750 might not even scratch the surface of some fairly basic medical procedures. Take, for example, a simple natural birth, one of the most fundamental human experiences which, according to Fair Health Consumer , would set back an uninsured person living in Portland, OR more than $20,000. Although that cost varies depending on location, its clear to see that additional coverage is necessary for most.
Furthermore, although the tax-free nature of FSAs is attractive, the prospect of forfeiting parts of a paycheck is definitely notand there are other ways to save cash for medical expenses and other emergencies which offer not just flexibility, but growth.
For example, the average savings account earns 0.50% APY in interest, and up to 0.80%, per the latest FDIC rate cap information, which isnt a huge return, but is more than the 0% youll earn on an FSA. That said, the value of tax-free dollars could easily eclipse the interest rate if the funds in the FSA are actually used.
While an FSA can be a beneficial tool, especially for those who know theyll spend a decent amount out of pocket on healthcare, a SoFi Money® cash management account can add additional help in this instance there are no account fees and account holders can earn cashback while they save and spend.
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Maximize Your Hsa Assets
Here are some options for using your accumulated HSA contributions and investment returns in retirement. Remember, distributions for qualified medical expenses are not taxable, so you want to use the money exclusively for those expenses if possible. There are no required minimum distributions, so you can keep the money invested until you need it.
If you do need to use the distributions for another purpose, they will be taxable. However, after age 65, you wont owe the 20% penalty. Using HSA assets for purposes other than qualified medical expenses is generally less detrimental to your finances once youve reached retirement age because you may be in a lower tax bracket if youve stopped working, reduced your hours, or changed jobs.
In this way, an HSA is effectively the same as a 401 or any other retirement account, with one key difference: There is no requirement to begin withdrawing the money at age 72. So you dont have to worry about saving too much in your HSA and not being able to use it all effectively.
Separate Your Required Spending From Your Discretionary Spending
This approach could make it possible for you to retire even sooner. With this strategy, you retire as soon as your portfolio balance is large enough to take care of your bare necessities.
But if your portfolio grows beyond its starting point or if you add income , then you can increase your spending on the wanna haves like more travel, out-to-eat, and entertainment.
You may be surprised at how quickly you could retire if you were only planning to save enough to cover your basic needs in retirement. But youd need to be ok with living a limited lifestyle in years that your portfolio was not performing well.
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What Is An Fsa Account
Like an HSA, you can use a Flexible Spending Account to pay for your out-of-pocket medical expenses on a tax-free basis. Some expenses may include your copayments, deductibles, eligible prescriptions, insulin, and more. Unlike an HSA, you must open an account through your employer. You cannot beself-employedand have an FSA.
At the beginning of the year, you must determine how much you want to contribute toward your account. You, your employer, or both can contribute to your account. Your employer can deduct your contributions from your gross pay every pay period which makes them tax-free. Youre unable to make any changes to this amount unless there is a change to your employer or family status. These stipulations are specified by your plan.
FSAs are use it or lose it accounts. This means that if you have money left in your FSA at the end of the year, you will forfeit any remaining balance. However, some employers can allow for either a 2.5-month grace period or let you carry over up to $500.
How to determine the best fit for your needs
Now that you understand the basics, its important to determine which account is more suitable for your needs. Since everyone has a different financial situation, they may require a different recommendation. The following are some things that you should consider when deciding between an HSA and an FSA.
Beyond 4%: The Argument For Flexible Spending Rules In Retirement
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Michael Kitces recently conducted a study of the 4% rule to see if it holds true for longer time horizons. The William Bengen study that the 4% rule is based on didnt test the 4% withdrawal rate on retirement periods of longer than 33 years. Yet many FIRE retirees may be in retirement for 40-50 years. We need to address flexible spending rules in retirement.
Does that make the 4% rule too risky? Or, perhaps its too conservative? These are the questions that Kitces study set out to answer. And it revealed some fascinating data that everyone who plans to retire early should pay attention to.
Overall, Kitces found that the 4% rule is inadequate for FIRE retirees. Rather than a hard-fast application of the 4% rule, he recommends that early retirees set flexible spending rules in retirement.
Below, weve summarized some of the studys key findings.
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Flexible Spending Rules In Retirement: Bottom Line
The FIRE movement is all about freedom and independence. It seems only fitting that FIRE retirees should have more freedom and flexibility in retirement spending as well.
Michael Kitces makes a compelling case for why early retirees may want to ditch the traditional usage of the 4% rule and choose flexible spending rules in retirement instead. You can check out his full article here.