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Helping Clients Determine the Right FSA and HSA Amounts

April 28, 2020   |   by Alex Strautman

They are two questions that come up each year, “What is the right amount to contribute to a Health FSA (Flexible Spending Account)?” and “What amount should I contribute to my HSA (Health Savings Account)?”

If you want to help your clients and their employees answer these questions, here are some things to consider.

Health Flexible Spending Accounts

A Flexible Spending Account (FSA) allows employees to set aside pre-tax dollars, which can be used to pay for qualified expenses under Internal Revenue Code (IRC) Section 213 (d). Health FSA dollars can generally be used to pay for eligible medical, dental, and vision care expenses – co-payments, coinsurance, or entire expenses not covered by insurance (for example, LASIK surgery). In some circumstances, qualified expenses can be limited within an FSA – such as a Limited Purpose FSA.

At the beginning of each FSA plan year, participating employees proactively elect the amount they wish to have withheld from their paychecks on a pre-tax basis, to be used on qualified expenses. Funds that employees put into an FSA are “use it or lose it” funds, which means amounts not spent by the end of the benefits year are lost and forfeited back to the employer. That makes it even more important for your clients’ employees to consider carefully their annual FSA contribution amount.

For 2020, the Internal Revenue Service (IRS) allows individuals to contribute up to $2,750 to a health FSA or limited purpose FSA. This represents a $50 increase from 2019 and a $100 increase from 2018. The employer, however, has full discretion at setting its own plan election limitation – as long as it does not exceed the tax year maximum allowed by the IRS. Health FSAs also provide “uniform coverage,” which means all elected dollars are available to employees on the first day of their plans – even if no payroll deductions have been withheld yet. This puts pressure on employers to evaluate carefully the maximum FSA election amounts extended to employees.

Employers may contribute to and fund employee FSAs, as long as the total dollar amount per employee does not exceed IRS limitations. An exception to this is when the employer elects to match dollar-for-dollar elections. In this case, an employee could have an amount in his or her FSA account that is greater than the IRS limits, though it is uncommon.

What to Consider in Choosing an FSA Amount

In determining an FSA contribution amount, employees should look at:

  • Out-of-pocket medical expenses from the prior year (e.g., medication co-pays, primary care or specialist office visit co-pays, therapy and counseling, medical devices, etc.)
  • Forecast expenses for the year ahead (e.g., medication co-pays, office visit co-pays, anticipated out-of-pocket costs for planned surgery or hospitalization, such as possible maternity expenses, if applicable). Checking the employee’s health plan schedule, which shows co-pays, can help with these estimates.
  • Estimated out-of-pockets costs for Dental care (including routine and specialty care co-pays, orthodontia, etc.)
  • Estimated out-of-pocket costs for routine Vision care (including co-pays, glasses, contacts, LASIK surgery, etc.)

Some businesses allow employees to carry over a portion – up to $500 – of their unused FSA funds into the next plan year. Other employers offer a 2.5-month grace period, allowing employees to continue incurring expenses for an additional 2.5 months after the conclusion of the plan year, overlapping the beginning of a new plan year. An employer cannot offer both, nor is the employer required to offer either.

Generally, for businesses that allow for rollover of health FSA funds, any amount that rolls over into the new plan year does not affect the employee’s maximum health FSA limit.

It is important employees know what applies to their specific FSA plan, so they can be strategic in determining what FSA contribution makes the most sense.

Health Savings Accounts

HSAs are tax-advantaged savings accounts to help employees with a High Deductible Health Plan manage their health care expenses. Qualifying HDHPs have a minimum deductible of $1,400 for individuals and $2,800 for families. In 2020, the annual out-of-pocket expense limit for an HDHP for self-only coverage is $6,900 and $13,800 for family coverage. Annual limits are linked to inflation, although medical cost growth often outpaces inflation annually.

Under IRS rules for 2020, the HSA limit for individuals is $3,550 (up $50 from last year) and $7,100 for families (up $100 from 2019). The catch-up contribution limit for employees age 55 or older remains at $1,000.

Among the benefits available with an HSA are:

  • Tax-deductible contributions: Amounts contributed are pre-tax, which reduces employees’ taxable income.
  • Tax-free earnings: HSA contributions and their interest earnings grow tax-free.
  • Tax-free withdrawals: When used to pay for qualified medical expenses like co-pays, prescription drugs, and related costs, employees can withdraw money tax-free.

Unlike an FSA, money contributed to an HSA does not expire. If an employee does not use all of his or her funds contributed during the year, it rolls over (similar to a regular savings account) – and the employee owns the funds for life, meaning he or she can even take it when moving to another job. However, unlike FSAs, “uniform coverage” does not exist for HSAs. Dollars must be in the HSA account in order to spend them.

The employee can utilize funds in an HSA for qualified medical expenses at any time, regardless of the health plan he or she selects. In order to contribute to an HSA, the person must be actively enrolled in an HDHP.

An employee is never required to use HSA funds at any given time. In fact, many use a Health Savings Account as a savings account itself. Some individuals fund the account with pre-tax dollars, allowing it to grow over time, to be used later. HSA account holders can also withdraw funds at any time – even years after the fact, as long as those eligible expenses occurred after the establishment of the HSA account. Claims substantiation (valid receipts or Explanations of Benefits) must be provided to withdraw funds from an HSA.

An HSA can be opened at most banking institutions, and/or can be established by an employer and funded through payroll deductions.

What to Consider in Choosing an HSA Amount

Although an employee is not taking the same kind of risk in “over-funding” his or her HSA, it’s still a good idea to look at prior and anticipated medical-related expenses to determine the right annual HSA contribution amount. These can include:

  • Out-of-pocket medical expenses from the prior year
  • Forecast expenses for the plan year
  • Expected out-of-pocket costs for Dental care (including routine and specialty care co-pays) and Vision care (including co-pays and the costs for glasses or contacts)
  • “Extra funds” to help with anticipated expenses during retirement (see below)
  • Other funds to grow the Health Savings Account

Post-Retirement Benefits

Beginning at age 65, an employee can use HSA funds to pay for Medicare premiums, tax-free. If an employee wants to use HSA funds for something other than health care, he or she can without penalty; however, income tax is due on the distribution – just like with a 401(k) withdrawal.

A smart strategy for pre-age 65 employees who have access to an HSA might be to contribute the maximum amount each year. That’s because health care expenses during retirement will likely be higher than expected, and once an employee enrolls in Medicare, he or she can no longer contribute to an HSA. The compound earnings component of an HSA offers employees the opportunity to accumulate a large amount of money, which they can invest to cover future living or medical expenses during retirement (after age 65).

In addition, unlike a 401(k) plan, eligible dollars used in an HSA account are not taxed. When a person pays for Medicare premiums with HSA dollars, the person is never taxed on those dollars. If a person pays for Medicare premiums with a 401(K), the payouts from the 401(K) are treated as income and are taxed.

Added Resources

Count on your Word & Brown team to help you understand FSAs, HSAs, Health Reimbursement Arrangements (HRAs), and Premium Only Plan (POP) compliance. Contact WBCompliance via email at compliancesupport@wordandbrown.com, or call 866.375.2039.

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