As many clients have seen their out-of-pocket health-related expenses rise with the implementation of the Affordable Care Act, finding a tax-preferred method for funding those expenses has become more important than ever. The options, however, have expanded in recent years and the rules have grown more complex—meaning that more clients may have difficulty determining which supplemental health account best suits their needs.
For a client who is lucky enough to have access to both a health savings account (HSA) and a health flexible spending account (FSA) to fund these expenses, expert advice as to the rules governing each type of account can prove critical to making sure each client makes the most of his or her health savings vehicle.
When Does an HSA Fit?
As a basic matter, the IRS has established limits on the use of HSAs so that only individuals with certain types of health plans are eligible to participate. HSAs are geared toward plans with higher deductibles; to qualify, a high deductible health plan (HDHP) must have a deductible that exceeds $1,300 for an individual plan or $2,600 for a family plan in 2015. Annual contributions to HSAs in 2015 are limited to $3,350 for individuals or $6,650 for families.
HSAs allow the client to adjust his or her contribution limits throughout the year, so that if the client is uncertain as to the level of his or her out-of-pocket expenses for the year, there is some flexibility. Additionally, amounts contributed to an HSA are rolled over from one year to the next (indefinitely) if the client does not need to use the funds in the year of contribution.
Further, an HSA will not be lost if the client changes jobs (though his or her ability to contribute may be lost if a new employer offers health coverage that does not qualify as an HDHP).
HDHPs generally require the client to fund a greater portion of his or her own health care before the insurance actually kicks in, meaning that clients with these plans might be better off contributing to an HSA because it comes with a higher contribution limit.
Despite these advantages, the implementation of the ACA Cadillac tax in 2018 may serve to limit the tax advantages of the HSA. Because pre-tax HSA contributions will likely be counted in calculating the cost of employer-provided coverage, many employers are likely to limit HSA contributions to after-tax dollars in the future. The funds will still be withdrawn tax-free to pay for qualified medical expenses, but the benefit of reducing taxable income through contributions may be lost (though the final Cadillac tax rules have yet to be released).
The Health FSA Difference
A primary advantage to the health FSA when compared to HSAs is that the client does not have to be enrolled in an HDHP in order to take advantage of a health FSA. However, the contribution limits to these accounts are lower ($2,550 in 2015) and unused amounts are generally forfeited at the end of the year (though either a 2.5-month grace period or $500 carryover may be permitted, depending upon the specific FSA).