Planning matters

HSA vs. FSA – Which is Better?

We’re putting two of the least-understood employee benefits in a head-to-head contest. Last week, we covered the pros and cons of the Flexible Spending Account (FSA). This week, we’re giving equal time to the newer, even less understood Health Savings Account (HSA).

The Health Savings Account (HSA)

HSAs have grown tremendously in popularity since their introduction in 2004, but we find are still confused with the better-known Flexible Spending Account (FSA). No wonder, as the names are so similar! But the HSA is a very different vehicle and is one of the most tax-efficient tools available for building retirement savings.

How so? Like their FSA cousin, money that goes into an HSA can be deducted from taxes, lowering your taxable income. And withdrawals are tax-free as long as funds are being used to pay for eligible unreimbursed medical expenses. They sound a lot alike so far, right?

But in addition:

  • Deposits into the HSA can be invested, so they can grow over time. Your HSA plan may require that the account balance exceeds certain minimums before allowing investment of a portion.
  • There’s no requirement to deplete the account by a specific date, so you can accumulate money over the course of several years. No “use it or lose it” rule with the HSA! Not only that, you can take any unspent funds with you when you leave your employer.
  • The tax-deductible contributions can be made from payroll reduction or in periodic lump sums, up to a maximum amount of $3,400 single/$6,750 family (for 2007). If you are over age 55, you’re allowed to put in $1,000/year more! Increase, decrease, start, stop or top off whenever you choose.

Given all of these additional benefits, why wouldn’t everyone use an HSA for their medical savings?

First of all, you must be a participant in a qualified High Deductible Health Plan (HDHP) – that is, a health plan with a deductible that’s greater than $1,300 for an individual or $2,600 for a family. Not all HDHPs are considered HSA-eligible, so it’s a good idea to check.

Second, you can’t contribute to an HSA if you switch to a non-qualified health plan, are listed as a dependent on someone else’s tax return, or go on Medicare. You can keep any HSA savings already accumulated, but won’t be able to add any new funds.

Lastly, HSAs aren’t necessarily appropriate for everyone. For example, they may not make sense for families who need frequent and/or specialized medical care. They tend to be best for healthy people who don’t use the doctor often, allowing for a greater build-up of funds in the HSA account over time while paying lower health insurance premiums for the high-deductible coverage.

Evaluating your health insurance and savings options are an important aspect of the financial planning process. If you have multiple choices from your employer or would like additional clarification about how each of these plans work, please be sure to talk with your planner.

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