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Understanding Healthcare Account Types and Their Purpose

A healthcare account is a tool that helps you manage health-related expenses and information in an organized way. Several types of accounts exist, each designed for different purposes and situations. This guide explains what these accounts are, how they function, and what information they contain so you can understand your options better.

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Health Savings Accounts (HSAs) are financial accounts linked to high-deductible health insurance plans. According to the IRS, as of 2024, approximately 33 million Americans hold HSAs. These accounts let you set aside pre-tax money specifically for medical expenses. You contribute money throughout the year, and the funds remain in the account until you need them for qualified medical costs like doctor visits, prescriptions, or dental work.

Flexible Spending Accounts (FSAs) work differently. These employer-sponsored accounts allow you to set aside pre-tax income for healthcare expenses during each calendar year. Unlike HSAs, FSA funds don't roll over—you typically must use the money within that plan year or lose it, though some plans offer a limited grace period.

Medical Savings Accounts (MSAs) are similar to HSAs but less common. They're available to self-employed people and employees of small businesses. Dependent Care FSAs are another variation that covers childcare expenses instead of medical costs.

Understanding these different account types matters because each has distinct rules about who can open one, how much you can contribute, and what expenses qualify. The right account depends on your employment situation, income level, and healthcare needs. Many people benefit from having multiple account types if their situation allows.

Practical takeaway: Write down which account types might fit your situation—employee with employer insurance, self-employed, or small business owner—then continue reading to learn more about how each one works.

How Healthcare Accounts Save You Money on Taxes

One of the main advantages of healthcare accounts is the tax savings they provide. When you contribute money to an HSA or FSA, that money comes out of your paycheck before federal income taxes, Social Security taxes, and Medicare taxes are calculated. This reduces the amount of income subject to taxation.

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Here's a concrete example: Suppose you earn $50,000 per year and contribute $2,000 to an FSA. Your taxable income becomes $48,000 instead of $50,000. If you're in the 22% federal tax bracket, that $2,000 contribution saves you approximately $440 in federal taxes alone. Add state and local taxes, plus Social Security and Medicare taxes, and the total savings could reach $600 or more depending on where you live.

HSAs offer an additional advantage that FSAs don't: triple tax benefits. First, contributions reduce your taxable income. Second, the money in the account grows tax-free if invested in stocks or mutual funds. Third, withdrawals for qualified medical expenses aren't taxed. The IRS reports that this makes HSAs one of the most tax-advantaged savings vehicles available.

FSAs provide tax savings on contributions but don't offer the investment growth benefit or long-term savings potential. However, for people who know they'll have regular medical expenses like prescriptions or therapy, an FSA can still produce significant annual tax savings.

The specific tax savings depend on your tax bracket, state of residence, and how much you contribute. Someone in a higher tax bracket saves more per dollar contributed than someone in a lower bracket. These accounts make sense financially for many people because they reduce the total cost of healthcare by lowering taxes owed.

Practical takeaway: Calculate your tax bracket (found on your most recent tax return) and estimate your annual medical expenses. Multiply your expenses by your tax bracket percentage to see approximate tax savings a healthcare account could provide.

Contribution Limits and How They Work Each Year

The government sets annual limits on how much money you can contribute to healthcare accounts. These limits change each year and vary by account type. Knowing these limits helps you plan how much money to set aside.

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For 2024, HSA contribution limits are $4,150 for individual coverage and $8,300 for family coverage. People age 55 and older can contribute an additional $1,000 catch-up amount. These limits apply to contributions made by you and your employer combined. For example, if your employer contributes $1,500 to your HSA, you can only contribute $2,650 yourself that year to stay within the $4,150 limit.

FSA contribution limits for 2024 are $3,300 per year, regardless of whether you have individual or family coverage. This amount is set by the IRS based on inflation adjustments. Some employers offer FSAs with lower limits, but $3,300 is the current legal maximum.

These limits reset each calendar year. If you have an FSA, you must decide how much to contribute during your employer's open enrollment period, which typically occurs in the fall. Once you make your choice, you generally can't change it during the year unless you have a qualifying life event, such as marriage, birth of a child, or significant change in employment.

HSA contributions can be made until the tax filing deadline (usually April 15) for the previous year, giving you more flexibility than FSAs. If you leave a job with an HSA, the account stays yours—you own it completely. FSAs, however, are owned by your employer, so if you leave the job, you lose access to remaining funds.

Understanding these limits prevents over-contributions, which trigger taxes and penalties. The IRS charges a 6% excise tax each year on excess amounts that remain in the account.

Practical takeaway: Review your previous year's medical expenses and prescriptions to estimate what amount you should contribute this year. Stay below the annual limits to avoid penalties.

Qualified Medical Expenses Explained

Not all health-related costs qualify for payment through healthcare accounts. The IRS maintains a specific list of qualified medical expenses. Understanding what counts helps you use these accounts effectively and avoid penalties for non-qualified withdrawals.

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Qualified expenses include payments to doctors, dentists, therapists, and other licensed medical professionals. Hospital stays, surgery, urgent care visits, and emergency room visits all count. Prescription medications and insulin are qualified, as are over-the-counter medications like pain relievers and cold medicines if you have a prescription for them. Interestingly, over-the-counter items without a prescription didn't qualify for many years, but rules changed in 2020 to allow more flexibility with certain products.

Vision and dental care are major qualified expense categories often overlooked. Eye exams, glasses, contact lenses, and laser eye surgery all qualify. Dental work including cleanings, fillings, crowns, orthodontia, and root canals count as well. Hearing aids and hearing tests qualify too.

Mental health treatment qualifies if provided by a licensed practitioner. This includes therapy, counseling, and psychiatric care. Physical therapy, rehabilitation services, and treatment for addiction also count.

Items that don't count include cosmetic procedures unless medically necessary, general wellness products like vitamins (with some exceptions), gym memberships, and most over-the-counter items without a prescription. Cosmetic dental work like teeth whitening doesn't count, but medically necessary root canals do.

Insurance premiums sometimes qualify but with restrictions. You can't use HSA or FSA funds to pay regular health insurance premiums. However, if you're receiving unemployment benefits, you can use HSA funds to pay for COBRA health insurance continuation coverage. Medicare premiums (Parts A, B, and D) can be paid with HSA funds after age 65.

The IRS publishes a comprehensive list of thousands of items and services on their website. When in doubt about whether an expense qualifies, consult IRS Publication 969 for HSAs or Publication 915 for FSAs.

Practical takeaway: Keep all receipts and medical documentation from healthcare expenses. Create a spreadsheet categorizing expenses as qualified or non-qualified to track what you can reimburse yourself for throughout the year.

Opening and Managing Your Healthcare Account

Opening a healthcare account involves several steps that vary depending on whether your employer offers one or you're seeking an HSA independently. Most working people gain access to these accounts through their employers during open enrollment periods.

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If your employer offers an FSA or HSA