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How much have you spent on your health care in the last 12 months? Would you believe Americans spent $12,914 per person on health care expenses in 2021? That’s a fact, according to the National Health Expenditure Accounts.
While you probably can’t eliminate your health care expenses, you may be able to save yourself some money by paying those bills with pre-tax funds. That’s automatic savings! Individuals with personal or group coverage (not Medicare) may have access to health care savings accounts that can be used independently or even paired together to maximize tax benefits.
Health Savings Accounts (HSAs) can be combined with Limited Purpose Flexible Spending Accounts (LPFSA); and Health Reimbursement Accounts (HRA) can be combined with Health Care Flexible Spending Accounts (HCFSA). Understanding how these accounts work independently and in coordination is important so you can get tax benefits without worrying about breaking the rules.
Health Savings Accounts
HSAs allow individuals with high deductible health plans (group insurance or personally owned coverage) to contribute up to $8,300 in pre-tax dollars in 2024, plus an additional $1,000 for those age 55+. Hands down these accounts are the most flexible and provide the greatest benefits.
Contributions can be directed through any combination of payroll deferrals, employer contributions, and personal lumpsum contributions. Funds can then be invested to grow for future needs and/or distributed tax-free for qualified medical, prescription, vision, and dental expenses. The list of eligible expenses ranges from sunscreen to health insurance deductibles. Employer contributions are vested immediately, and the funds can remain in the account indefinitely. Investing the funds sets account owners up for a triple tax advantage: pre-tax contributions, tax-deferred growth, and tax-free distributions for qualifying expenses.
Distributions for non-eligible expenses are subject to ordinary income tax. If account owners are under the age of 65, a 20% penalty also applies. Account owners over age 65 avoid the penalty.
Limited Purpose Flexible Spending Accounts
LPFSAs serve as a partner account to HSA accounts (and only HSAs). Individuals can defer up to $3,200 to the account, pre-tax, in 2024. Only the employee can contribute to the LPFSA, not the employer). LPFSA funds cannot be invested, and any balance remaining in the account at the end of the year is forfeited. Distributions are only allowed for qualifying vision and dental expenses. It’s best to estimate your vision and dental costs for the year and only fund the account up to that amount.
You don’t want to risk losing any funds at year-end. Some plans will allow you to roll over a small balance into the next calendar year (up to $640 in 2024), but they aren’t required. It’s important to note – your employer owns the funds in your LPFSA, so if you leave your employer, you also forfeit any remaining funds.
Combining HSA and LPFSAs
Using these accounts together can be a powerful planning tool. Let’s assume you are healthy but expect $2,000 in out-of-pocket expenses for dental work. Fund the HSA with $8,300 and invest those funds so they can grow tax-free for future needs. Fund the LPFSA with $2,000 and use those funds to pay your dental bills. If you’re in the 22% tax bracket, you’ve saved $2,266 in taxes by deferring $10,300 into the HSA and LPFSA.
Health Reimbursement Accounts
HRAs are set up by employers and can only be used with certain health insurance plans. Contributions are made by the employer only and are not considered income to the employee. Distributions can only be made for eligible medical expenses, not vision or dental.
Funds can be rolled over to future years but are not eligible for investment. If you leave your employer, you also forfeit any remaining HRA balance. However, if you retire, the plan may allow you to maintain the account.
Health Care Flexible Spending Account
HCFSAs are the partner account to HRAs and are very similar to LPFSA accounts. Employees can make pre-tax contributions up to $3,200 in 2024.
Employers don’t contribute to these plans, and the funds cannot be invested. Distributions for eligible medical, dental, and vision are tax-free. Like the LPFSA, the account has a use-it-or-lose-it structure; also, with the ability to allow participants to roll up to $640 to the next calendar year.
Combining HRAs and HCFSAs
Sticking with the same example above, a healthy individual with $2,000 in dental expenses can benefit from an HRA and an HCFSA. The HCFSA can be funded with pre-tax employee contributions of $2,000, while the HRA is funded with employer contributions. The HCFSA can be used for dental bills, leaving the funds in the HRA to roll forward to the next calendar year. If you are in the 22% tax bracket, you’ll save $440 in taxes by contributing to the HCFSA.
The Right Combo
The right health care savings account(s) will depend on your employee benefits and health insurance coverage. If you can pair an HSA with an LPFSA or an HRA with an HCFSA, you can maximize your savings by planning ahead.
Sarah Mahaffa, CFP® is a Wealth Advisor at Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.BedelFinancial.com or email Sarah at smahaffa@bedelfinancial.com.