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

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

Comments

[B. Johnson]

I wonder at Mr. McCarthy's comment "We've warned against these plans for most consumers." My wife and I are 39 and 36, have 5 children, and meet the median income in our county--our HSA is a great fit for us and has made us smarter consumers of care. Should we be so unfortunate as to max out our $10k deductable, that's a loss we can recover from. And all costs above that are 100% covered by the plan. We recommend such plans, and think Mr. McCarthy should too.

[Kathy]

As a single, middle-aged, unwealthy woman, I could not be more pleased with my HDHP with HSA. My employer contributes a portion to both the premium and the savings account. It didn't take long for the HSA to grow to the point where it covers the annual deductible and catestrophic limit. The tax advantages are outstanding at any tax-paying bracket. I sense some political bias against these plans from the the editors.

[John]

I'm confused at to why the negative comment regarding High Deductible Health Plans (HDHP). Whether you are healthy or not the cost of insurance is going to be based on the insurer protecting themselves from higher claims. What I have found is that with traditional plans you will pay the insurance company every month for the potential of claims vs. going with a HDHP with an HSA that gives me the opportunity to save what I don't use. In the comparisons I have done, the cost of maxing out a HDHP including premiums and deductible have always been less than the cost of the premiums and deductible (and in many cases just the cost of premiums) of a traditional plan. The real beauty is that I win since there is no use it or lose it concern. What I don't use will roll over every year and can be used to help pay medical expenses in my retirement. Personally I think an HDHP with an HSA is actually a better plan for most when you really do the math. It also makes me a better health care shopping consumer, since I want to keep as much of my savings as possible, which may help reduce the overall cost of health care.

[Michael]

I'm a retired civil service employee who was fortunate enough to have a RHS (Registered Health Savings plan) plan available from my employer in CA. As I worked I accrued sick hours, holiday hours, vacation hours and compensenatory hours. After 26+ years service I had over 2,200 hours saved. When I retired all those hours were converted to cash at my hourly rate. I walked away with over 66k in a tax free self directed investment account. Under the IRS guidelines any medical expense, medical, dental, eyeglasses, as long as its medical I can access the account and be reimbursed into my checking account as long as I supply the medical or perscription resceipts. I cannot tell you how nice this has been. If you have a similar opportunity, do it ASAP. If the "Self directed investment" part scares you, and it might in this economy. Put it in T-bills. Not much interest but no loss either. I can also cover my wife and son until the money is gone.

[Frank]

My employer is now offering a high deductible plan with an HSA as an alternative to a traditional HMO type. It has the same provider network and the employer pays the entire deductible and all set up fees. I'm not young and not wealthy. I really can't see any disadvantage to switching to the HSA, can you? Am I missing something?

[rani gill]

HSA's are a great alternative for me - young, pretty healthy, no dependent, on COBRA with a high deductible plan. But I'd rather have a simpler alternative with comprehensive health care. The US system of FSAs, HSAs, COBRA, high-deductible, comprehensive, plus many other plans is incredibly, ridiculously complicated. Having grown up in Canada, I never thought about health care -- I took it for granted. It was simple and straightforward -- why can't we do that here?

[Cosmo Barone]

Letter to Consummer Reports:

In you article “Two prescriptions for American ills”, you did a great job of comparing the Obama and McCain medical plans, but you ignored the central problem. Neither plan is feasible because the United States cannot afford any addition to our current entitlements, let alone a new one.

“Once the nation digs its way out of the current financial crisis, another fiscal landslide looms - the entitlement crunch. Without structural reforms in Medicare, Medicaid and Social Security, the Congressional Budget Office estimates those three programs - which guarantee benefits to anyone who meets eligibility requirements - will rise from 18 percent of GDP today to 28 percent by 2050 and even more as time goes by.” That means either crippling tax increases that will smother economic vitality or painful benefit cuts that will hit low- and middle-income retirees hardest.” Quoted from Ignoring entitlements, Candidates fall short on huge spending programs, Rocky Mountain News, Published October 5, 2008 at 11:18 p.m.

Our country will soon be bankrupt. My children, grandchildren, and great grand children will get no benefits at all, unless you count getting to pay for my benefits.

Cosmo Barone
address on file at Consumer Reports

PS: I couldn'd find your "letters" address anywhere.