Health Savings Accounts (HSAs) provide a triple tax break—money contributed to them is tax-free…it grows tax-deferred…and withdrawals are tax-free as long as they are for health-related expenses. Unfortunately, employees often make costly mistakes with HSAs, perhaps because these accounts differ in subtle ways from the Flexible Spending Accounts (FSAs) with which many employees are more familiar. With an HSA…
Your account might be underfunded at the outset. With FSAs, the full amount contributed to the account is available from the start of the year. With HSAs, funds are available only after they actually are deposited. If you make contributions to your HSA via payroll deductions throughout the year and/or your employer makes a contribution on your behalf but divides this up into quarterly installments, there might not be enough money in the HSA early in the year to pay for a big medical expense or for ongoing smaller expenses.
Payroll deductions are better than money transfers. You can deposit money into your HSA simply by transferring cash from a different account if you like—but unless you need to get a lot of money into your HSA quickly, depositing money through payroll deductions is the better option. While all contributions to HSAs are income tax–free, only payroll deductions also avoid FICA taxes—that is, Social Security and Medicare contributions. (As of 2015, total annual contributions to an HSA from both employee and employer are capped at $3,350 for an individual or $6,650 for a family. Those age 55 and older can contribute an additional $1,000.)
Money deposited in your HSA is yours to keep. With an FSA, you would lose the money deposited in the account if, for example, you fail to spend the money by the end of the plan year or shortly thereafter. With an HSA, any money that goes in is yours until you spend it, with no deadlines (though there are penalties for spending this money on nonmedical expenses). If you don’t have substantial medical expenses during the current year, just leave the money in the account and use it in a future year.