Take Control of Healthcare Costs
Published on August 17th, 2022
When it comes to healthcare, it’s easy to feel like it’s out of your control. Understanding costs is an important part of managing healthcare expenses. Ideally you would know what to expect before even going to the doctor, but that is not always the case. The good news is that no matter your situation, there is a tax-advantaged account that can work for you. Let’s break down healthcare costs and see which tax-advantaged account would make the most sense for you.
Understanding Out-of-Pocket Healthcare Costs
With any health plan you choose comes the responsibility to pay for certain out-of-pocket healthcare expenses. However, the degree of coverage varies by plan option. Some factors, such as preventative care, coinsurance (plan share), and post-deductible expenses may be automatically covered. Certain expenses, like deductibles, prescriptions, copayments, dental, vision and coinsurance (your share) must be paid for out-of-pocket, which is where pre-tax accounts provide the most value.
How Health Benefit Accounts Work
If you had the opportunity to save 30% on every dollar you spend out of pocket, why wouldn’t you?
The way it works is relatively simple. You contribute funds to the pre-tax account, which comes out tax-free, up to a limit that is set by the IRS. That tax savings automatically puts you in the driver’s seat to spend on qualified expenses you incur or for saving, which is available as in the case of an HSA. This helps your spendable income stretch an average of 30% further. Additionally, you can grow your funds contributed tax-free with an HSA.
Long-Term Savings Potential of Health Benefit Accounts
Let’s take a look at how savings (like with an HSA) can play out in the long term. Take three examples in which an individual would have contributed three separate amounts – $50, $200 and the max $7200/per year – over a 25-year period. If you simply put in $50 a month over 25 years, you’d have a total balance of approximately $23,000 dollars and have saved around $2,500 in taxes. Increase that amount up to $200 and you are at over $90k in savings and $10k in tax savings. Contribute $7,200, and you are looking at over $275k and $30k in taxes saved over that time. Pretty appealing scenario, right?
Understanding Pre-Tax Account Options
Now that you have a baseline understanding of consumer-directed healthcare (CDH) accounts, let’s dive deeper into each account type.
Health Savings Account (HSA)
A health savings account (HSA) is similar to a checking or savings account at the bank, except the funds are only used to pay for current and future qualified healthcare expenses. It’s important to note the account is owned by you and therefore can be taken with you if you leave your current employer. An HSA must be paired with a high-deductible health plan, which means lower monthly premiums, but of course also higher deductible amounts. The dollars you contribute to an HSA are pre-tax, meaning your taxable income is lowered as well. You can use the HSA funds to pay for medical expenses as they accumulate, and if you don’t use the funds, they are allowed to grow over time. A big perk of an HSA is that the interest you earn on the dollars contributed grows tax-free and, once taken out, also comes out tax-free. This creates a triple-tax advantage that differentiates HSAs from other benefit accounts.
You can contribute up to a certain amount annually in your HSA based on your marital status. If you are 55 years or older, you can add $1,000 to the maximum contribution in what’s called a “catch-up contribution.” Contributions can be adjusted up or down at any time throughout the plan year.
Flexible Spending Account (FSA)
The major difference to note between an HSA and FSA comes in how unused funds are handled at the end of the plan year. With an FSA, funds you don’t use can either be forfeited, rolled over up to $500 or given a grace period for funds to be used of up to 90 days into the following year. Here are a few more key differences and similarities between an HSA and FSA:
|Employer owns the account||Consumer owns the account|
|Consumer elects an annual amount and funds the account through pre-tax withholdings from their paycheck. Employer sometimes contributes funds as well.||Consumer elects and annual amount and funds the account through pre-tax withholdings from their paycheck. Employer sometimes contribute funds as well, a process known as employer seeding.|
|Consumer has immediate access to the annual amount elected. For example, if a consumer elects an annual amount of $2,000, that full amount is available at the start of the plan year.||Consumer can only access funds as they build up in the account. For example, if a consumer elects an annual amount of $2,000 to be withdrawn from their paycheck in $83 increments, they will have access to only $83 after their first paycheck.|
|Annual FSA contribution limit for 2022: $2,850. Consumer determines election amount during open enrollment and can only change that amount in the case of a qualifying life event, such as marriage or the birth of a child.||Annual HSA contribution limits for 2022: $3,650 (individual coverage) and $7,200 (family coverage). Consumer can adjust election amount at any time.|
|Employer receives any unused funds at the end of the year that cannot be rolled over, at the end of a specified grace period, or when a consumer leaves the company.||Consumer owns his or her HSA funds for life. These funds can build up over time for long-term healthcare savings and for use in retirement. Consumer can withdraw funds at any time without penalty, as long as they are used on eligible items.|
Limited Purpose Flexible Spending Account (LPFSA)
There is also a special kind of FSA, called a limited purpose FSA, which has the same characteristics of a healthcare FSA, except that the funds contributed can only be used to pay for dental or vision expenses. This is helpful for those looking to take advantage of both the savings advantages of an HSA, while being able to also take advantage of the cost savings from being in an LPFSA.
Health Reimbursement Arrangement (HRA)
A health reimbursement arrangement, or HRA, is unique in that the funds to the account are contributed entirely by the organization as a means to help you, the employee, cover the high deductible associated with the plan. It is similar to an FSA in that the account is owned by your employer and has specific dates in which the funds contributed may be used. You can use the funds to pay for typical medical expenses not covered by your health insurance plan, like doctor’s office visits, copays, prescription drugs and hospital services.
Individual Coverage Health Reimbursement Arrangement (ICHRA)
An individual coverage health reimbursement arrangement, or ICHRA, is a reimbursement account set up and funded by the organization that helps you pay for qualified medical expenses incurred throughout the plan year. An ICHRA is designed to help offset out-of-pocket financial responsibilities associated with your healthcare. The funds in the account can be used to pay for individual health insurance premiums as well as eligible out-of-pocket medical expenses such as doctor’s office visits, copays, prescription drugs and hospital services. The money your employer contributes to the account is not included in your salary and is not considered taxable income.
Dependent Care Flexible Spending Account (DCFSA)
A dependent care account is a great option for those who are paying for expenses associated with the care of children or older family relatives. With this type of account, similar to other CDH accounts, the money you contribute comes out tax-free, which saves you an average of 30%. Eligible expenses that qualify for DCFSA funds can vary from items like before- or after-school childcare, preschool, day camps, holiday camps and so forth. The funds can also be used for costs associated with elderly adult care.
A commuter benefit account is great for employees who incur costs associated with their commute to or from work. They are broken down into two major categories – mass transit and parking – with transit applying to items like passes, tokens and fare cards, and parking being associated with costs to park near or at your place of employment. Like other accounts, there are maximum contribution amounts. A commuter benefit account is dictated on a monthly basis, with the limit for both mass transit and parking currently being $270 per month. You are able to change the amount you elect to contribute on a monthly basis. Funds you don’t use may be transferred over to the next year, so long as you continue to participate in the plan.