Flexible Spending Plans

Saving money for healthcare expenses is a simple idea. That’s the idea behind flexible spending plans.

With flexible spending plans, you set aside pretax money from your paycheck (or your employer contributes pretax money) to pay for healthcare expenses. Because the money isn’t taxed, you’ll have more money to spend than if you use income that has been taxed. In effect, you’re stretching your healthcare dollars.

There are three basic types of flexible spending plans. What they all have in common is that you can use the money only for what are called “qualified medical expenses.” Those are items that the Internal Revenue Service (IRS) says you can deduct as a medical or dental expense when you file your taxes. Examples include copays and other out-of-pocket expenses for doctor visits, dental visits, hospital services, prescription drugs and eyeglasses. The list is subject to change, but the current version can be found here.

Two kinds of flexible spending plans are available only if you’re employed by someone else—the flexible spending account and the health reimbursement account. A third kind, the health savings account, is also available to self-employed people.

Flexible Spending Account
A flexible spending account (also called a flexible spending arrangement, or FSA) is set up by your employer. You decide whether to participate and, if so, how much you want to contribute each pay period. For 2019, you could contribute up to $2,700 per year. Your employer can contribute to your FSA too, if your employer wishes.

You can use the money in your FSA to pay for any qualified medical expenses. The FSA operates on a “use it or lose it” basis. You generally have to use up the money within your health plan year. If you don’t, you lose whatever is left over.

There are two exceptions. Your employer may choose to give you a grace period of up to two and a half extra months to use the money, or can allow you to carry over up to $500 to use the following year. Your employer can offer either option but not both, and isn’t obligated to offer either.

Because of the “use it or lose it” restriction, it’s important to think carefully about how much you want to contribute per year to the FSA. Too much, and you may lose funds; too little, and you lose a potential tax advantage.

If your employer offers an FSA, you generally can enroll at hiring or during open enrollment. Each year at open enrollment, you have to re-enroll if you want to continue the FSA.

Health Reimbursement Account
A health reimbursement account (also called a health reimbursement arrangement, or HRA) is set up by your employer. Only your employer contributes to the account. There’s no limit on how much can be contributed. You’re reimbursed tax-free for qualified medical expenses up to a fixed dollar amount per year. Unused funds may be rolled over to be used in later years.

If your employer offers an HRA, you generally can enroll at hiring or during open enrollment. You have to re-enroll each year at open enrollment if you want to continue the HRA.

Health Savings Account
Your employer may offer a health savings account (HSA) and make contributions to it. Or you can establish an HSA yourself with a qualified HSA trustee, such as a bank or brokerage firm. An HSA is meant to be used by people with a high-deductible health plan (HDHP); to qualify, you must have such a plan. That’s a plan where the annual deductible—the amount you must pay for healthcare before your insurer begins to pay—is higher than it is for typical plans. For plan year 2020, the deductible for an HDHP must be at least $1,400 for self-only coverage and $2,800 for family coverage. (There are other restrictions on what makes a plan an HDHP and how to qualify for an HSA; see the IRS rules here. For information on how much you can contribute to an HSA in 2020, see here.)

An HSA is tax-exempt. You can claim a tax deduction for any money you contribute. The money you take from it isn’t taxed as long as you use it for qualified medical expenses. Interest or other earnings on the account are tax-free. The contributions you make to your HSA stay there until you use them.

You can set up an HSA whether you’re self-employed or work for an outside employer. The money stays with you if you change employers. You can even carry the money into retirement. If your employer contributes to your HSA, such contributions aren’t taxed as income.

If you’re under 65 and you use HSA funds for something other than qualified medical expenses, you have to pay taxes on the withdrawal and a 20 percent penalty. Once you reach 65, you still have to pay taxes on such withdrawals, but not penalties.

If you get your HSA through your employer, you generally enroll at hiring or during open enrollment. If you open an HSA yourself, you can do it any time of the year.

For more information, see our FH® Insurance Basics article on Flexible Spending Plans.