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Updated: July 11, 2019
Medical costs are expensive. Health insurance obviously helps, but it doesn’t cover everything, and you’ll inevitably come across stuff that you’ll have to pay for yourself.
That’s where flexible spending accounts (or flexible spending arrangements. Up to you.) and health savings accounts come in.
FSAs and HSAs are a way for you to help pay for some of your medical expenses that insurance won’t cover – and help you with your taxes along the way.
So what is a flexible spending account, or FSA? An FSA is used to help people pay for medical expenses that they have to pay for out of pocket.
"But I can just pay for stuff myself with my normal money, right?"
Yes, you can. But an FSA is specifically set up to help you save money by saving on your taxes.
Here’s how it works: your FSA is made available through your employer, which means they have to offer it through their benefits and you can’t just go and sign up on your own (but if they do offer it, contributing to an FSA is completely optional). It’s preloaded by your employer at the beginning of the year, and throughout the year funds are deducted from your paycheck to pay for it.
But your contributions are pre-tax. Whatever you contribute is deducted from your taxable income come April, so instead of paying tax on a hypothetical $40,000, you’re only paying it on $38,000.
This is good for employees, but it also works out for employers because it reduces the payroll tax they owe, usually by more than it takes to offer an FSA.
There are some limits on FSA. First, only certain qualified medical expenses are eligible. We’ll get to those in a bit, but you can’t spend the money on whatever you’d like.
Second, they’re offered on a "use it or lose it" basis. At the end of the year, you lose any money that’s left in your account. Employers can offer some alternatives, like allowing up to $500 to roll over or giving a grace period of up to two and a half months to use what’s left in your account, but it’s typically best to use everything you have. That means estimating how much you’ll spend so you don’t contribute too much money and end up wasting it.
On a similar note, because your FSA is employer-provided, you’ll lose access to it when you leave (or get fired, but we’ll be optimistic and assume you chose to leave). No rolling it over between years, and no rolling it over between jobs. And speaking of leaving: even though your FSA is prefunded, you don’t have to pay back whatever’s leftover in your account when you leave. You could theoretically use it all up at the beginning of the year and then leave; that’s possible if you’re actually quitting, but not as helpful if you’re being fired since most people aren’t given a head’s up in that case.
Finally, there are contribution limits. For a regular medical FSA, that’s $2,650 a year for 2018. For a dependent care FSA, which you can use on your dependents for things like day care for young children or care for older children who are physically or mentally unable to take care of themselves while you work, you can contribute up to $5,000 a year.
I know, they sound similar – and they are! – but there are a few key differences between FSAs and health savings accounts.
We already know that an FSA is available to you only through your employer. An HSA is yours and is available outside of work, which is nice because that means you don’t lose it if you leave your job.
HSAs are an investment product, so they earn interest. That means they have a triple tax advantage combo: you contribute the money pre-tax (just like an FSA), you’re not taxed when you use the money (just like an FSA), but the interest you earn also isn’t taxed (unlike an FSA, where you don’t earn interest, and also unlike traditional savings accounts, where the interest is taxed).
The amount you can carry over each year isn’t limited either. That $500 or two and a half month rollover? Not an issue with HSAs.
Sounding pretty good, right? HSAs aren’t a bad deal, but the kicker is they aren’t available to everyone.
You need to have a high deductible health plan in order to be eligible for an HSA. For 2018, that means a deductible of $1,350 for single coverage or $2,700 for a family plan. And you can’t have both an HSA and an FSA, unless you opt for a limited FSA, which covers only vision and dental expenses.
Other than that, though, HSAs and FSAs are used for the same purpose: paying for eligible medical expenses. What sort of expenses? Glad you asked.
There are some tricky things on the list of eligible medical expenses that you might not think about. Did you know you can pay for transportation costs or trips if they’re primarily for medical purposes? Because you can.
And if you have a dependent care FSA you can use it on things like child care while you work or adult day care for elderly people who live with you.
A few of the things eligible for FSA payment are:
Bandages – Basic medical supplies are great to use your FSA on, since you’ll probably need to restock anyway.
Eyeglasses – Since FSA amounts are typically lost at the end of the year, a popular suggestion is to buy yourself some glasses if you have money that needs to be spent.
Insurance Premiums – Not all insurance premiums are eligible; for example, life insurance or disability insurance aren’t eligible, but "insurance premiums you pay for policies that cover medical care" are. Most premiums associated with your basic health insurance are covered.
Physical Examination – Get one every year!
Television – For extra equipment like making it ready for a hearing-disabled person.
Wig – If it’s "purchased upon the advice of a physician for the mental health of a patient who has lost all of his or her hair from disease," not just because you want to change up your look.
If you want a full list of what does and does not qualify for FSA payment, check out the IRS’s website. There are a huge number of eligible expenses, and you’ll want to use up your FSA by the end of the year so you don’t lose out on any of that money.
In general, you can’t use your FSA to pay for things that contribute to your general health (like diet foods or gym memberships) or things that are solely for aesthetic improvement (like cosmetic surgery).
What does and doesn’t count as an eligible expense can get tricky. For example, membership in a weight loss program is eligible...or it could be ineligible.
Confused? Well, a weight loss program is an eligible expense "if it is a treatment for a specific disease diagnosed by a physician (such as obesity, hypertension, or heart disease)." But if "the purpose of the weight loss is the improvement of appearance, general health, or sense of well-being," then you’re out of luck.
Massages are similar. They don’t count if you just want one to unwind after a stressful week, but if you have a doctor’s note that it’s for medical purposes, then it’s okay.
Some highlights from the ineligible list:
Dancing Lessons – No tax-free salsa lessons for you.
Flexible Spending Account – You can’t pay for your FSA with FSA money. It probably puts you in some sort of Inception-like trap that you can’t escape.
Health Savings Accounts – Also, you can’t pay for your HSA with your FSA. Good try, though.
Insurance Premiums – See the previous list. Some are eligible, some aren’t.
Personal Use Items – Aka "stuff." You can’t use your FSA to just buy stuff.
Again, check out the full list from the IRS for all of the details. The last thing you want to do is paid for an unqualified expense: it comes with a 20% tax penalty.
An FSA is definitely something to look into if it’s available to you. You’ll likely be paying for medical expenses anyway, so why not get the tax break, right?
But remember, since you lose the money at the end of the year, sit down and figure out just how much you might need.
Heck, that’s even a good time to go over your overall budget and make sure that’s in good health, too.
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