Tax-Advantaged Health Accounts

Thoughtware Article Published: Oct 06, 2021
Tax Advisor

Choosing the correct healthcare plan can be a difficult task. For families with two working adults, this decision becomes even more complicated. Do you split into two plans, or do you select one employer’s plan and join as a family? After making that decision, you’ll then need to choose between enrolling in a health flexible spending account (FSA) or health savings account (HSA). Each option offers attractive tax benefits for taxpayers to consider. Both options share the common goal of using pretax dollars to pay for qualified healthcare expenditures. It’s important to understand both plans to make the right choice for your family. 

Ownership

A key distinction between the two plans is who has ownership and control over the account. An HSA is owned by the employee, meaning an HSA isn’t tied to employment. Therefore, termination of employment won’t forfeit the account balance. In fact, an employee or a self-employed taxpayer can set up an HSA through a bank, credit union, or brokerage institution. 

An FSA, on the other hand, isn’t so flexible in that an employee can only participate in a plan through their employer. Termination of employment may cost an individual their remaining account balance. While the Taxpayer Certainty and Disaster Tax Relief Act of 2020 allows for post-termination reimbursements from health and dependent care FSAs through the end of the 2021 plan year, such reimbursements aren’t required. Because the plan is owned by the employer, only the employer—not the employee—may amend the plan to include post-termination reimbursements allowed by this legislation. 

Contributions

The HSA offers a higher contribution limit in 2021 of $3,600 for self-only coverage and $7,200 for family coverage, which can be adjusted at any point during the year. This amount is higher than the FSA due to the potential for higher out-of-pocket expenses and to accommodate the savings feature of the plan. Conversely, FSAs allow just $2,750 in annual contributions for both individual and family accounts. The annual contribution for an FSA must be determined during the open enrollment period and can’t be adjusted after open enrollment closes. 

The HSA allows taxpayers over the age of 55 to make a catch-up contribution up to $1,000 per year. This is available until age 65 or until enrolling in Medicare. 

FSA “Use It or Lose It” 

The online marketplace is well represented with stores dedicated to spending FSA dollars. These sites are marketing to taxpayers who need to spend their funds to avoid forfeiture under the “use it or lose it” rules. Employers have two options to avoid application of these rules: 

  1. Employers can include language in the plan to allow for an optional grace period, extending no later than March 15 of the following year, in which employees may spend current-year funds. 
  2. Employers can allow plan participants to carry over up to $550 of their unused balance to the following year. 

The Taxpayer Certainty and Disaster Tax Relief Act of 2020 permits an employer to amend their plan and allow for a 12-month grace period and a carryover of all unused benefits. Like the post-termination reimbursement rules, however, the employer is in complete control of the application of this relief—not the employee. This relief will expire in 2022. 

Because the HSA is a savings account, the “use it or lose it” rules don’t apply. The plan is designed to pay for qualified medical expenditures, like an FSA, with the added benefit to save for future healthcare expenditures. Some plans give the owner the ability to invest the account’s available funds. Any realized gains from the investment are tax-free when used to pay for qualified medical expenses. 

Choice & Eligibility

Taxpayers may not have a choice between the two plans, however. HSA accounts are only available to individuals or families participating in a high-deductible healthcare plan (HDHP). For calendar-year 2022, an HDHP is defined as a health plan with an annual deductible that is not less than $1,400 for self-only coverage or $2,800 for family coverage, with annual out-of-pocket expenses that don’t exceed $7,050 and $14,100, respectively. If a plan doesn’t meet these criteria, then the only option is participation in an FSA account. 

Once you understand the differences in both plans, you may question the “flexibility” of the FSA. Even though it’s less flexible than an HSA, an FSA is still beneficial because employees can save up to $1,000 in taxes with the maximum contribution of $2,750. Those who determine an HDHP is the appropriate health plan for their family may pair it with an HSA and achieve even more tax savings, with the added benefit of investing in their future healthcare.

For more information on healthcare accounts or other fringe benefits, IRS Publication 15-B is a great resource. BKD’s 2020 Fringe Benefits Refresher also covers reminders on other fringe benefits such as moving expenses, gifts and rewards, and employer-provided vehicles. 

For more information, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below.

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