Flexible Spending Accounts (Part 2)

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How Do Health FSAs Work?

At the beginning of the year, you elect the total amount you want to have withdrawn from your paychecks to put into your FSA, and your employer will deposit the money into the account in equal allotments throughout the year. The IRS has outlined rules guiding eligibility, contributions and reimbursements.

FSA Eligibility

FSAs are employer-sponsored benefit plans, and the employer can choose what other type of group health plan coverage to offer with the FSA.  FSAs can be offered with any type of health plan—FSAs are not tied to a high deductible health plan (HDHP) like health savings accounts (HSAs) are. Self-employed individuals are not eligible for an FSA, and restrictions may apply for highly compensated individuals or key employees.

Opening Your FSA

The FSA is sponsored by your employer as one of your employee benefits. You will need to choose how much you want to contribute to your FSA. The amount you elect will be for the entire plan year, and your employer will then deduct the corresponding amount from your paycheck with each pay cycle. This is sometimes referred to as a salary reduction arrangement.

Contributions

After your initial contribution election, you ordinarily cannot change your election for a plan year during the year. Your elected contribution amount can only be changed if you experience a permitted election change event, such as a change in family status and your FSA permits you to change your election.

The amount you choose to transfer into your FSA should be based on the amount of qualifying medical expenses you anticipate your family incurring during the plan year. Start by looking at your family’s medical expenses for the past year and then determine whether your family will likely have those same expenses again and whether there will likely be any new expenses. Use this estimate to help you choose what amount you would like to contribute to your FSA, remembering that it is typically best to underestimate by a little than to overestimate and lose that money at the end of the year.

Limits – Effective Jan. 1, 2013, the maximum amount you can contribute each year to your FSA is $2,500, which will be indexed for inflation and therefore may change year to year. The employer may implement a lower annual limit than the federal maximum.

Who can contribute – Both you and your employer may contribute to your FSA. However, your employer is not obligated to contribute to the account.

Grace Periods and Carry-overs

The FSA operates with a use-or-lose rule, meaning if you don’t use the money in your FSA by the end of the plan year, you will lose it. However, the use-or-lose rule was relaxed with two options that employers may choose to offer: a grace period or a carry-over. The grace period can last up to 2 ½ months into the next year, typically March 15 for a calendar year plan. Generally, only expenses you incur during the plan year can be reimbursed from the funds in your FSA, but if your FSA has a grace period, you can use those unused funds in your FSA for expenses incurred during the grace period.

Under the carry-over option, an FSA may allow participants to carry over up to $500 in unused money at the end of the plan year to be used to reimburse expenses incurred in the next year. The carry-over does not count toward the annual maximum allowable contribution.  Employers are not required to offer either of these options, and they may only offer one of the two options, not both.

If you have funds in your FSA at the end of the year, you might consider scheduling a checkup, dental cleaning or similar appointment before the end of the year in order to use up the leftover funds before they are lost.

Using Your Health FSA

FSAs must comply with a uniform coverage rule. The uniform coverage rule provides that an employee’s entire annual FSA election amount, less any amount already used, must be available at any time of the plan year—even if that full amount has yet to be contributed to the account. This means that the entire amount of your election is available for your use at any time of the year. For example, if you elect $1,000 for your annual contribution, and you incur qualified medical expenses of $800 in January, your FSA will reimburse you for the $800 even though that amount has not yet been deducted from your salary.

When you are paying for a qualified medical expense that you would like to use your FSA funds for, you typically have two choices: using a health payment card or requesting reimbursement.

Health Payment Card
Some employers may provide you with a health care payment card, which is very similar to a debit or credit card, and you can pay for eligible medical services or products by swiping the card as you would a debit or credit card. The money will then be deducted from your FSA account.

Health care payment cards may be used only on eligible medical expenses that are not reimbursed or covered by another source. Over-the-counter (OTC) medications are only eligible for reimbursement if they are prescribed to you, and you present the prescription at the time of purchase. The only OTC medication that can be reimbursed without a prescription is insulin. Health care payment cards may not be used to cover more than the maximum dollar amount of coverage available in your FSA.

As a general rule, every claim paid with a health care payment card must be reviewed and substantiated. The IRS guidance allows automatic adjudication for certain card transactions, meaning that receipts do not need to be submitted for verification of expenses for which a health care payment card is used. This applies in three situations at medical providers and 90-percent pharmacies (which are drug stores and pharmacies where at least 90 percent of the store’s gross receipts during the prior taxable year consisted of medical expenses):

  • When the total cost of the transaction is equal to the standard copayment for the service(s) received
  • When the transaction is for recurring expenses that have previously been approved
  • When the merchant provides expense verification to the employer when the transaction takes place

Reimbursement
Another way to pay for eligible medical expenses with your FSA funds is to pay out-of-pocket and then submit receipts for reimbursement. Your account will have specific instructions for how to do this. When submitting for reimbursement, you will need your receipts and proof that what you paid for was an eligible medical expense; this is one of the reasons it is important to keep all receipts and related paperwork from your health care provider.

 

Qualified Expenses

Employees may use their health FSAs to pay for or reimburse themselves for their own eligible medical expenses, as well as their spouses’ and dependents’ eligible medical expenses.  Eligible medical expenses are unreimbursed medical care expenses, as defined under Section 213(d) of the Internal Revenue Code. An employer can more narrowly define the expenses that can be reimbursed from an FSA. Health FSAs cannot be used to pay for non-medical expenses. Your FSA cannot be used to pay for health insurance premiums, long-term care coverage or expenses, or amounts already covered under another health plan. See Appendix for a list of qualified medical expenses.

Flexible Spending Accounts (Part 1)

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What Are Health FSAs?

An FSA is an employer-sponsored savings account for health care expenses. You are not taxed on the money put into the FSA, and you can then use the account to pay for qualified out-of-pocket health care costs, such as your deductible and copays, but not your premium. However, you cannot stockpile money in the account from year to year, and you will lose leftover money in the account at the end of the plan year unless your employer offers an option that allows for either a short extension or a small carry-over into the next year.

FSAs were created in the 1970s to enable employees to use pre-tax dollars for health care expenses that were not otherwise covered by employer-sponsored health coverage. These accounts gained more popularity in the 2000s, and they underwent a few changes with the Affordable Care Act (ACA), including the addition of an annual contribution limit.

Health FSAs can save you money on taxes while helping you regularly put aside money for health care expenses. If carefully planned, using an FSA for health care costs can be an asset to your family’s budget.

 

Why Have a Health FSA?

Health FSAs offer an option for setting aside money to use for qualified medical expenses. These accounts offer a convenient way to prepare for out-of-pocket medical expenses while saving on taxes. In addition, you can use your health FSA to pay not only for your medical expenses, but also for the medical expenses of your spouse and dependents.

 

Health FSA Advantages

Here are some of the advantages an FSA can provide:

Tax reductions: The amount you contribute to a health FSA is not subject to federal income tax or social security (FICA) tax—effectively adjusting your annual taxable salary. The taxes you pay each paycheck and collectively each plan year can be reduced significantly.

  • Your employer can also contribute to your FSA, and this amount is also not considered taxable income to you.
  • You can withdraw money from your FSA to pay for qualified medical expenses (see Appendix) and your withdrawals are not taxed.
  • You do not have to report FSA amounts on your income tax return.

Convenience: After the initial election at the beginning of the year, your employer will take care of transferring the allotted amount into your FSA through salary deferral.

Flexibility: You can withdraw health FSA funds at any time (for qualified medical expenses), even if the amount has not yet been deposited into the account, as long as the amount is no more than your elected annual deferral amount less any amount already used.

 

Is a Health FSA Right for You?

FSAs can save you money because you don’t have to pay taxes on the amount deferred to the account. However, using an FSA does require careful planning in order to reap the financial benefits.

When you participate in an FSA, you have to decide at the beginning of the plan year how much to contribute for the year. Because you will generally lose what you don’t use by the end of the year, determining how much to defer into an FSA can be challenging. While correctly estimating your health care expenses and using an FSA to pay for those expenses will save you money, incorrectly gauging your health costs could cause you to lose money.

How your employer manages the FSA may also affect how much you will benefit from using an FSA. If the employer provides a grace period or carry-over option (see “Grace periods and carry-overs” section), you will have a little more flexibility when using your FSA funds. The largest downside to using an FSA is that if you over fund your FSA and don’t use the amount in there, you will lose what you’ve saved.

Health Plan Identifier (HPID) Requirement & Impact on HRA/FSA Plans

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New rules require health plans to obtain a unique Health Plan Identifier (HPID), which eventually must be used by plans, providers, insurers, and others in all standard transactions.  The HPID requirement is an effort to standardize health care transactions in order to reduce the cost and increase the quality of heath care.  The requirements for full compliance differ depending on the size and structure of the plan.  Although the deadline for large health plans to obtain the HPID is fast approaching, further guidance from HHS would be welcome to clarify the rules.  As of today, it is our view that all HRAs and FSAs administered by ProBenefits do not need to register this year due to a small plan exception.  A summary of the topic, including a discussion of plans subject to the requirement and the deadline for compliance, can be found here.

Health Savings Accounts (Part 2)

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How Do HSAs Work?

To have an HSA and make contributions to the account, you must meet several basic qualifications.  Here’s what you need to know to start saving with an HSA.

HSA Eligibility – In order to qualify for an HSA, you must be an adult who meets the following qualifications:

  • Have coverage under an HSA-qualified, high deductible health plan (HDHP)
  • Have no other health insurance plan (this exclusion does not apply to certain other types of insurance, such as dental, vision, disability or long-term care coverage)
  • Are not enrolled in Medicare
  • Cannot be claimed as a dependent on someone else’s tax return

HSAs must be used with an HDHP. To qualify as an HDHP, a health plan must satisfy requirements for the minimum annual deductible and the maximum out-of-pocket expenses.

In 2014, the minimum annual deductible for a qualifying HDHP is $1,250 for an individual and $2,500 for a family. For 2015, the HDHP minimum deductible will be $1,300 for an individual and $2,600 for a family.

In addition, annual out-of-pocket expenses under the plan (including deductibles, copays and coinsurance) cannot exceed $6,350 in 2014 and $6,450 in 2015 for single coverage, and $12,700 in 2014 and $12,900 in 2015 for family coverage.

In general, the deductible must apply to all medical expenses (including prescriptions) covered by the plan. However, plans can pay for preventive care services on a first-dollar basis (that is, without a deductible or copay). Preventive care can include care such as routine prenatal and well-child care, child and adult immunizations, annual physicals and mammograms.

Opening Your HSA – Your employer may offer an HSA option, or you can open an account on your own through a bank or other financial institution. Banks, credit unions, insurance companies and other financial institutions are all permitted to be trustees or custodians of these accounts. Other financial institutions that handle IRAs or Archer MSAs are also automatically qualified to establish HSAs.

Contributions – Contributions to your HSA can be deducted when you file your income taxes. If your employer offers a Section 125 plan (sometimes called a “cafeteria plan”), you may be able to make your HSA contributions on a pre-tax basis. That means that your HSA contribution will be taken out of your wages and no federal income tax or employment tax will be withheld on the contribution.

Determining your contribution – Your eligibility to contribute to an HSA is determined monthly. You must have HDHP coverage on the first day of the month to make an HSA contribution for that month.  There is a limited exception that allows individuals who become HSA-eligible during a calendar year to make the full contribution amount for that year. Under this exception, individuals who are eligible to contribute to an HSA on Dec. 1 of a calendar year are allowed to contribute an amount equal to the annual HSA contribution amount provided they remained covered by the HSA for at least the 12-month period following that year. Contributions can be made as late as April 15 of the following year.

Limits – You can make a contribution to your HSA for each month that you are eligible. For each month that you are eligible, you can contribute one-twelfth of the annual maximum for HSA contributions. The full contribution rule described above for individuals who are eligible on Dec. 1 of a calendar year is an exception to the rule that HSA contributions limits are determined monthly. You can contribute no more than the designated annual maximum. For 2014, this is $3,300 for single coverage and $6,550 for family coverage. For 2015, the maximum is $3,350 for single coverage and $6,650 for family coverage. Individuals who are age 55 and older can also make additional “catch-up” contributions of up to $1,000 annually.

Who can contribute – Contributions to your HSA can be made by anyone, including you, your employer or a family member; the combined contributions of you and your employer (and anyone else making contributions to your HSA) can not exceed the HSA maximum contribution limit.

Contributions to the account must stop once you are enrolled in Medicare. However, you can still use your HSA funds to pay for medical expenses tax-free.

Using Your HSA

An HSA is managed by the account holder, giving you the choice of when to use your HSA dollars. You can begin using your HSA money as soon as your account is activated and contributions have been made. You can use your HSA account for any purpose, including paying expenses that are not qualified medical expenses. However, you only get the tax benefits of an HSA when you use the account for qualified medical expenses. If you use it for another purpose, you will be required to pay income tax on the withdrawal, and you may also be required to pay another 20 percent tax, unless you make the withdrawal after you reach age 65, become disabled or after your death.

Qualified Medical Expenses

You can use money in your HSA to pay for any qualified medical expense permitted under federal tax law, which includes most medical care and services, as well as dental and vision care. HSA distributions are tax-free if they are used for qualified medical expenses incurred by the account holder or his or her spouse or dependents. The qualified medical expenses must be incurred after the HSA is established.

Qualified medical expenses are defined in Section 213(d) of the federal tax code. Section 213(d) defines “medical care” to include amounts paid “for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body.”

You can use your HSA account to pay for your health plan deductible, your copay or coinsurance for doctor’s office visits and prescription drugs, your share of the cost for dental care, such as exams and cleanings, and your costs for vision care, such as exams, eyeglasses and contact lenses. See Appendix B for a list of eligible expenses.

Generally, you cannot use your HSA to pay for medical insurance premiums, except specific instances, including:

  • Any health plan coverage while receiving federal or state unemployment benefits
  • Continuation coverage under federal law (COBRA or USERRA coverage)
  • Qualified long-term care insurance
  • Any deductible health insurance for HSA account holders who are age 65 or over (whether or not they are entitled to Medicare) other than a Medicare supplemental policy

You can use your HSA to pay for medical expenses for yourself, your spouse or your dependent children, even if your dependents are not covered by your HDHP. Any amounts used for purposes other than to pay for qualified medical expenses are taxable as income and subject to an additional 20 percent penalty. Examples of taxable expenses include:

  • Medical procedures and expenses not considered qualified under federal tax law
  • Over-the-counter drugs and medications without a prescription (except insulin)
  • Other types of health insurance unless specifically described above
  • Medicare supplement insurance premiums
  • Non health-related expenses

After the age of 65, you can withdraw money for nonmedical expenses without penalty, but you will have to pay taxes on the money. If you become disabled, the account can be used for other purposes without paying the additional penalty. If you withdraw money from an HSA for non-medical expenses before you turn 65 (or become disabled), you will have to both pay taxes and a 20 percent penalty.

To Read Part 1, Click here!

Health Savings Accounts (Part 1)

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What Are HSAs?

Health savings accounts (HSAs) are a great way to save money and efficiently pay for medical expenses. HSAs are tax-advantaged savings accounts that accompany high deductible health plans (HDHPs).

HSAs were created in 2003 to provide individuals who have HDHPs with a tax-preferred method of saving money for medical expenses. There are certain advantages to putting money into these accounts, including investment earnings and favorable tax treatment. The rationale behind the HSA/HDHP combination is that people will have a clearer idea of their medical costs and more control over their spending, enabling them to reduce their medical costs.

HSA money can be used tax-free when paying for qualified medical expenses, helping you pay your HDHP’s larger deductible. At the end of the year, you keep any unspent money in your HSA. This rolled over money can grow with tax-deferred investment earnings, and, if it is used to pay for qualified medical expenses, then the money will continue to be tax-free. Your HSA and the money in it belongs to you—not your employer or insurance company.

An HSA can be a tremendous asset as you save for and pay medical bills because it gives you tax advantages, more control over your own spending and the ability to save for future expenses.

 

Why Have an HSA?

HSA/HDHPs take a different approach to health coverage than other plans with lower deductibles. Having an HSA provides you with many benefits, including flexibility and easy saving, helping you plan and pay for medical expenses.

HSA Advantages

Here are some of the advantages an HSA provides you with:

  • Security – Your HSA can provide a savings buffer for unexpected or high medical bills.
  • Affordability – In most cases, you can lower your monthly health insurance premiums when you switch to health insurance coverage with a higher deductible, and these HDHPs can be paired with an HSA.
  • Flexibility – You can use your HSA to pay for current medical expenses, including your deductible and expenses that your insurance may not cover, or you can save your funds for future medical expenses, such as:

Health insurance or medical expenses if unemployed

Medical expenses after retirement (before Medicare)

Out-of-pocket expenses when covered by Medicare

Long-term care expenses and insurance

Also, you do not have to use your HSA to pay for medical expenses. You can withdraw money from your HSA at any time and for any reason. However, if your HSA money is not used for medical expenses, you will have to pay income tax on your withdrawal. You will also have to pay a 20 percent additional tax, unless the withdrawal is made after you attain age 65, become disabled or after your death.

  • Savings – You can save the money in your HSA for future medical expenses, all while your account grows through tax-deferred investment earnings.
  • Tax Savings – An HSA provides you with triple tax savings:

Tax deductions when you contribute to your account

Tax-free earnings through investment

Tax-free withdrawals for qualified medical expenses

  • Control – You make the decisions regarding:

How much money you will put in the account

When to make contributions to the account

Whether to save the account for future expenses or pay current medical expenses

Which expenses to pay for from the account

How to invest the money in the account

  • Portability – Accounts are completely portable, meaning you can keep your HSA even if you:

Change jobs

Change your medical coverage

Become unemployed

Move to another state

Ownership – Funds remain in the account from year to year, just like an IRA. There are no “use it or lose it” rules for HSAs, making it a great way to save money for future medical expenses.

 

Is an HSA Right for You?

HSAs are a growing trend in health care and offer many advantages, but whether it’s the right choice for you depends on several factors.

Comparing HSA/HDHPs to traditional health plans can be difficult, as each has pros and cons. For example, traditional health plans typically have higher monthly premiums, a smaller deductible and fixed copays. You pay less out-of-pocket costs due to the lower deductible, but you will pay more each month in premiums.

HDHPs with HSAs generally have lower monthly premiums and a higher deductible. You may pay more out-of-pocket medical expenses, but you can use your HSA to cover those costs, and you pay less each month for your premium.

The decision is different for each individual. If you are generally healthy and/or have a reasonable idea of your annual health care expenses, then you could save a lot of money from the lower premiums and valuable tax-advantaged account with an HSA/HDHP plan. For example, even someone with a chronic condition could take advantage of an HSA/HDHP plan if he or she has a good idea of his or her annual expenses and then budgets enough money to cover cost of care.

However, if you are older, more prone to illness or unexpected medical conditions, or prefer certainty in medical costs over the possible risk of unexpected out-of-pocket expenses, you may want to stick with a traditional plan. You’ll pay more in monthly premiums, but you will have a lower deductible and fixed copays.

Read more about How HSA’s work on Thursday!


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