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The Future of U.S. Health Care? FSAs & HSAs

Bob Sullivan
Flexible Spending Accounts and Health Savings Accounts may sound similar, but they are very different. Here's what you need to know about them. 

With the election of Donald Trump as president, the future of Obamacare is uncertain. But whatever changes come to the way Americans pay for health care, one thing seems certain: A growing number will pay with their own money using pre-tax dollars through health savings accounts or flexible spending accounts. Already, there are nearly 65 million so-called "account-based health plans" in use, and as their number continues to soar, so too will confusion around the tax-friendly-but-red-tape-heavy health care payment plans.

While these two ways to pay sound similar, they are very different, and these distinctions matter a lot to both your health care and your financial future. So, here's a bit of history.

FSAs & HSAs: A Primer

Flexible Spending Accounts, which date back to the 1970s, let workers set aside money from each paycheck to pay for out-of-pocket health care costs throughout the year. About 35 million Americans use an FSA, according to the Employers Council on Flexible Compensation.

Their cousin in savings-based health care spending, the Health Savings Account, is a far more recent invention. More like an IRA for lifetime health care costs, they came to be in experimental form under Bill Clinton's watch in 1996 as part of the Health Insurance Portability and Accountability Act (HIPPA). But they weren't available to the general public until George Bush signed the law that expanded Medicare in 2003. Today, their popularity is soaring, in large part because of the growth of high-deductible (patient unfriendly) health care plans. While there were only 10 million HSA users in 2010, they are predicted to hit 30 million accounts by 2018, according to Devenir.com. Collectively, some $50 billion will be saved in HSAs by then.

There are other forms of account-based health care plans – sometimes called Health Reimbursement Arrangements or Healthcare Reimbursement Plans. But those accounts are owned by employers. To keep things focused, we will only discuss individual-owned plans here. (If you are really curious, Zanebenefits.com has a nice comparison chart.)

Get used to paying for health care with individual accounts, experts say, no matter what happens to Obamacare.

"The new users are active spenders, involved in how their health care dollars are spent and looking for the most effective way to use their health care account balances. The Affordable Care Act is in part responsible for the wave of new users," said Sarah Grotta, an analyst with Mercator, and author of a new report titled "The Growing Importance of Healthcare Accounts". "Survival of the ACA is in question after the presidential election, but the use of healthcare accounts has been considered positive and will likely be front and center as new health care policies emerge."

Consumers have mixed feelings about account-based health plans. The tax savings can be substantial, but so can the red tape — and the rules.

This time of year, many workers have just finished declaring their deductions for flexible spending accounts (election windows vary but are generally range from October to November). That means they were busy doing back-of-the-envelope calculations to guess how much they'll spend on health care in the next year — and deciding how much of their paychecks they'll siphon off into the account, up to $2,600. And as the year ends, they're also popping into eyeglass stores and other covered providers, looking to spend leftover funds from 2016 contributions that may be subject to a use-it-or-lose it rule.

Health Savings Accounts don't come with the use-it-or-lose it strings attached. Consumers who keep their money in an HSA can withdraw it to pay for health care costs at any time. And the savings can be invested, similar to an IRA. That makes them a much better deal, says Desmond Henry, a Kansas-based financial adviser.

Many consumers don't understand this critical distinction, however.

"They are really confusing," said Henry, in an interview with Credit.com. "I have clients I meet with all the time, they come in and a lot of times they generalize. They think they have a health savings account, but you go and look and it's an FSA, and then you realize they didn't spend all the money and they lost it. It's a common problem."

The rules for how accounts can be funded and spent can be even more confusing. There are no income limits to an HSA (unlike an IRA), theoretically, and any individual can invest up to $3,400 during 2017. But only consumers on high-deductible health care plans are eligible.

Some of the biggest gripes against flexible spending accounts have been addressed when spending rules were relaxed in 2013. Employers can now allow workers to carry over $500 annually (though that's only an option, check with your employer). Also, the IRS eased up on the "spend by Dec. 31" rule; consumers now have into March to spend last year's money. So there's no need to run out right now and buy a $500 humidifier before Dec. 31 (as one of my readers did not long ago).

Also, reimbursement has gotten easier for some patients. Instead of mailing in paper claims, many consumers can now spend the money using a prepaid card.

Count Christine Zeman, a New Jersey mom, among the crowd of FSA fans.

"(They're) great. Pre-tax money for contact lenses, insurance co-pays, prescription meds," she wrote on my Facebook page. "I used it for orthodontics — paid for two sets of braces so far, spread over a couple years each."

Josh Belzman of Seattle has more mixed feelings.

"A lot of stuff you'd think would be covered isn't, or stores don't accept the card, and it's dumb you have to guess what you'll use or lose it, though you can now carry over more. Still a pretty hackneyed system," he wrote.

Which Is Better?

HSAs have an important feature that's a big benefit over FSAs — contributions can be changed at any time. With an FSA, employees generally can't change their monthly contribution once it's set during the election period (Exceptions can be made for major life events, like the birth of a child).

Frustration with that restriction is one reason for HSA's meteoric rise. Trade group America's Health Insurance Plans says that while only 1 million people were enrolled in HSAs in 2005, that number had swelled to 10 million by 2010, and almost 20 million by 2015.

Their biggest attraction, however, is what some analyst call their triple tax benefit: The money can be contributed tax-free, lowering a consumer's annual tax bill; if invested, it can grow tax-free; and it can be withdrawn to pay for health care expenses tax-free.

"Love my HSA. I got mine directly at a bank," wrote Frank Miceli to me. "Money can stay in it and be invested. No 'use it or lose it' like an FSA. The money is your savings."

Employers like the HSA model because it softens the blow of offering cheaper (but unpopular with workers) high-deductible health care plan. And, like a 401K, money used to fund an HSA can come from the worker, the employer, or both. In 2015, 32% of all HSA dollars contributed to an HSA account came from an employer, Zenefits.com says.

Henry says that there's a hidden benefit to HSAs. They can act like an additional retirement savings account. Workers lucky enough to be maxing out contributions to IRAs or 401Ks should fully fund their HSAs, he said.

"If you are nearing retirement, and maxing out your 401K, this enables you another way to put money away and use it for health care in retirement," he said. The money can only be used tax-free for health care costs, but have no fear: they will come.

One concern that many health care consumers are likely to overlook with health savings accounts are the investment costs. Much like a 401K, HSAs offer limited investment options, and they may include high fees, like any mutual fund. Consumers worried about doctor bills are unlikely to prioritize researching mutual fund expense ratios, but they need to. Understandably, many consumers take the easiest option for setting up an HSA — through their employer's offering, for example — but consumers can shop around and obtain an HSA from any provider they choose.

For the long haul, it's best to pick simple investment options, like low-cost index fund mutual funds. But remember, if you feel pretty certain you'll need access to the money in the near term, you should keep it in cash, preferably in an FDIC-insured savings account. Otherwise, if your health care emergency comes during a stock market downturn, you'll have an even bigger headache to worry about.

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