Health-Care Savings Series—Day 6: Use tax-free accounts to stretch your health dollar

Oct 13, 2008 9:01 AM

If your employer offers Flexible Spending Accounts (FSAs), you can use them to stretch your health-care dollar. When you sign up, your employer will put whatever amount you want to contribute, typically up to $5,000 a year, from your wages straight into your spending account, before it's taxed. That means you won't pay income taxes on the money you spend on qualified health care expenses with your FSA. And employers may contribute as well.

Qualified expenses are generally anything that can be deducted, according to IRS Publication 502, which can include co-pays and prescription drugs. However, with an FSA, you can't pay for any insurance premiums, but you can pay for over-the-counter drugs.

The savings depend on your personal health spending and your tax bracket. The administrator of FSAs for federal employees, FSA FEDs, has an online calculator that can help you to estimate your savings.

The catch? It's use it or lose it. Whatever amount you put away in an FSA has to be used in that year; if you don't, it's gone forever. The remaining sum is forfeited back to your employer. So it pays to do some research up front.

Here are some tips for participating in an FSA:

Don't automatically max out your account because you might get sick. Only put away what you know you will use. If there’s a little left over, you may be able to use it to stock up on over-the-counter drugs and first-aid supplies, but if there's a lot, it’s gone.
Know what you can pay for with your FSA. Your employer should provide a list of what you can pay for and what you can’t, so make sure you include only qualified expenses when you decide how much to contribute to your account.
Save your receipts. You may need them to file a claim for reimbursement. And even if your FSA provides a point-of-purchase debit card to pay your health expenses, hold on to your receipts in case you need to provide proof that the purchase was a qualified expense.

Health Savings Accounts (HSAs) are a bit more risky than FSAs. HSAs, which allow you to put away pre-tax wages to pay health care expenses, are typically paired with a high-deductible health plan, sometimes called “catastrophic" insurance. These plans usually have lower premiums than more comprehensive coverage, but have much higher deductibles and co-pays.

Contributions are tax-deductible. They are invested and the interest earnings are tax-free. Unlike an FSA’s use-it-or-lose-it provision, HSAs accumulate and roll over indefinitely if you don’t spend the money in them. When you withdraw money from HSA to pay health expenses you pay no taxes, and after you hit 65 you can use the money for any purpose without a tax penalty.

We've warned against these plans for most consumers. They do little to help people with chronic illnesses, families with children, moderate-income and older Americans get access to affordable, quality health care. Instead, they transfer financial risk increasingly to consumers. But HSAs may benefit young healthy workers with no dependents, and the wealthy at any age. That’s because the higher your tax bracket, the more you can save. These plans may be able to help some save on health care, but they aren’t for everybody.

—Kevin McCarthy, associate editor

Tomorrow: Shop Around for Rx Drugs