Alphabet Soup – Understanding Medical Expense Accounts

Medical expense accounts offer a tax-advantaged means to save and pay for medical expenses that aren’t commonly covered by health insurance.

The four types of accounts are:

• Flexible Spending Arrangements (FSAs)
• Health Savings Accounts (HSAs)
• Health Reimbursement Arrangements (HRAs)
• Medical Savings Accounts (MSAs)

These four accounts have different eligibility requirements and contribution rules. The benefits they give to the account holder also differ.

The four types of accounts are similar yet different:

1. Flexible Spending Arrangements. A health care FSA benefits employers provide that allows an employee to set aside pre-tax funds to pay for medical expenses not covered by insurance.

• Eligibility: An employee is generally eligible if the employer offers the program. There are exceptions if the employee is highly compensated.
• Taxes: Contributions are pre-tax.
• Contributions and distributions: Contributions are made in equal amounts over the year. There is not a government-set limit to the amount of the contributions, but your employer is required to set a limit. You can use the funds for costs covered by the plan. You lose whatever money you don’t spend.

2. Health Savings Accounts. This tax-exempt account permits you to use your employer’s contributions and earnings to pay for medical expenses.

• Eligibility: There are many requirements to set up an HSA. It would be best to be covered by a qualified high deductible health plan (HDHP). You cannot be covered by any other insurance that helps with medical expenses. You must be under 65 years of age and not claimed as a dependent by another person.
• Taxes: You can make pre-tax contributions to your account. You can also make post-tax deductions and then take a deduction on your tax form. Your contributions grow tax-free until you need them. Withdrawals are tax-free for qualified purposes.
• Contributions and distributions: You and your employer can make contributions. The maximum contribution is $3,200 for an individual and $6,450 for a family. IRS Publication 502 defines qualified medical expenses. Unqualified withdrawals are subject to taxes and a 20% penalty. The 20% penalty only applies to those under 65.
• Funds are allowed to roll over.

3. Health Reimbursement Arrangements. An HRA is an account that the employer funds. Employees are reimbursed for medical expenses not covered under the employer-provided health plan.

• Eligibility: Any employee can participate if the employer has an HRA plan. Highly compensated employees can have limited contributions.
• Taxes: You are not taxed for your employer’s contributions.
• Contributions and distributions: Only employers can make contributions. The funds can be used for all qualified expenses, including health insurance premiums and long-term care insurance. Most employers allow unused funds to be carried over to the following year.

4. Medical Savings Accounts. This type of account is mainly obsolete. It is very similar to the HSA but considerably more flexible.

• Eligibility: The MSA was created for self-employed and employees of small businesses.
• Taxes: The same tax benefits are found in the HAS.
• Contributions and Distributions: It is not possible to start a new MSA or contribute further to one already established. It is, however, permissible to maintain an existing MSA and take qualified distributions. Any unqualified withdrawals are subject to taxes and a 15% penalty for those under 65.
• An MSA can be rolled over into a HSA.

Taking full advantage of your medical expense account can save you a lot of money.

These are just the highlights of each type of medical expense account. Be sure to learn more about the type of account that applies to your situation.

IRS Publication 969 covers all the details.