If you're trying to decide on a health insurance plan at your job, you'll likely see the terms "HSA" and "FSA." HSAs and FSAs are types of accounts that may be available to help you save money on health care expenses and taxes.
Here's how they work:
What Is an HSA?
HSA stands for health savings account. Think of it as a type of savings account for medical expenses. You can only set up an HSA if you also have an insurance plan with a high deductible. A deductible is the amount you have to pay for medical bills before your insurance plan kicks in.
HSAs aren't just for people who work for companies. If you're self-employed -- and have a high-deductible plan -- you can also set up an HSA.
Usually, an employer enrolls workers in a high-deductible plan and then deposits either all or a portion of the deductible in an HSA. For example, if you have a deductible of $5,000, the employer can put the $5,000 in an HSA. This money is not considered income, which means you don't have to pay taxes on it.
Also, if you are an employee, you may contribute extra funds to an HSA on a tax-free basis. In 2013, you could make contributions from your paycheck -- before paying taxes -- of up to $3,250 a year for yourself. For family coverage, the limit was $6,450. If you are self-employed, you can make tax-deductible contributions to your HSA.
If you are 55 or older, you can put in an extra $1,000 every year.
You can use the money in an HSA to pay for medical expenses until you reach your annual deductible. After that the health insurance policy covers additional medical expenses.
You can use HSA money for:
- Doctor visits
- Hospital stays
- Eyeglasses and contacts lenses
- Chiropractic care
- Prescription drugs
What Are the Tax Advantages of an HSA?
Like an IRA or a 401K account, you can keep your HSA even if you switch jobs. Any money you don't use can be rolled over from year to year and invested. If you use any of the money for nonmedical expenses before age 65, you will have to pay a 20% penalty. You will also have to pay taxes on the money you use.
An HSA offers a triple tax break because:
- Contributions are not considered income so are free from income taxes.
- You don't have to pay taxes on any increases in the amount of money in the HSA. If you want, you can shift money into mutual funds and other investments after your account balance reaches a certain level.
- There is no penalty for withdrawing the funds for medical expenses.