For 2023, the Internal Revenue Service has increased the allowable maximum contributions to health savings accounts (HSAs) and flexible spending accounts (FSAs). For HSAs, the new limit is $3,850 for single-individual plans and $7,750 for family plans. For FSAs, the new limit is $3,050 for healthcare plans, while the limit for dependent care plans remains unchanged at $5,000 per household. In addition to the new, higher limits for contributions, there are some points to consider for those using or considering the use of either an HSA or an FSA. Let’s take a look.
Flexible spending accounts have proven popular as a way to use pre-tax dollars to pay for allowable medical and dependent care expenses. As of late 2020, Americans had opened more than 20 million accounts, most of which are accompanied by employer-sponsored health plans, with contributions added by payroll deduction.
The principal weakness of FSAs is their “use-it-or-lose-it” attribute; funds not used during a year or during the rollover period allowed by some plans is forfeited. For example, in 2019 and 2020, plan contributors forfeited some $7.2 billion (about 40% of enrolled workers). Even with the deduction from taxable income provided by the contributions, that’s a lot of money left on the table.
This means that, if you are enrolled or considering enrollment in an FSA for 2023, you should think carefully about how you intend to use the money. Many FSA plans provide a debit card linked to the account, and it’s a great feeling to use the account to pay for prescriptions, office copays, eligible childcare costs, and other expenses allowed by your plan. But you want to be sure that you’re putting in the right amount: too little, and you’ll be paying out-of-pocket for expenses near the end of the year; too much, and you’ll be making an unplanned donation of forfeited contributions that will probably be retained by your employer.
It’s a good idea to track your medical costs and/or dependent care expenses, depending on how you’re using your FSA. By knowing about how much you tend to spend in a year, you’ll be able to make a more educated guess when it comes time to set up your payroll deduction (or other contribution method).
Health savings accounts must be used in combination with an eligible high-deductible healthcare insurance account (HDHP, “high-deductible health plan”). For 2023, the minimum deductible qualifying as an HDHP, according to the IRS, is $1,500 for an individual plan and $3,000 for a family plan. Funds in the HSA are then used to pay deductibles, copays, and other eligible expenses not covered by the HDHP.
Like FSA contributions, HSA contributions are pre-tax, and funds within the plan grow without being taxed. When they are withdrawn to pay eligible medical expenses, no tax is assessed on the withdrawal. After age 65, the plan owner may withdraw funds from the account for any reason with no penalty, but withdrawals not used to pay medical expenses may be taxed as ordinary income.
Unlike FSAs, HSAs have no “use-it-or-lose-it” limitations. Funds may be rolled over from year to year, continuing to accumulate without taxation until they are needed. In other words, they can offer three tax advantages: reduction of taxable income when contributions are made; tax-free growth within the account; and tax-free withdrawals for qualified healthcare expenses.
For persons who expect low healthcare costs during the year and who have the means to save extra money, an HSA can make a lot of sense. The higher deductible that comes with an HDHP means less money paid in premiums, and the tax-advantaged savings offered by the HSA means more control over the funds you allocate for potential healthcare costs.
As a fiduciary financial advisor and wealth manager, Griffin Black is dedicated to helping clients make tax-smart decisions about all their investments and savings, including provision for current and future healthcare costs. To learn more, click here to read our article on healthcare laws, “Surviving the Rule-Based World.”