Choose the Right Health Care Account: Stay Well - and Well-Financed - with an Array of Savings Options

EXECUTIVE SUMMARY * Health spending accounts offer opportunities for employees to save and pay for health care with pretax contributions. Three basic types are flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs) and health savings accounts (HSAs). * FSAs are typically funded by pretax payroll deduction and are subject to cafeteria plan regulations, including a rule that prevents carryover of unused amounts to future years, unless an employer has adopted a 2 1/2-month grace period provision. COBRA provisions, however, allow benefits to continue if an employee has a qualifying event such as termination of employment. * HRAs may accompany high-deductible health plan (HDHP) coverage, and the employer and employee may share the deductible's cost. An HRA must be funded solely by the employer and cannot be paid for by salary reduction. * HSAs allow tax-free investment growth, and distributions for medical expenses aren't included in income. HSAs must be paired with an HDHP covering the account owner. Owners can designate a spouse as beneficiary, and the account continues to be treated as an HSA after the death of the account holder and its transfer to the surviving spouse. Bart H. Siegel, CPA/PFS, CFP, CFE, is principal of Siege/Forensic Accounting and Consulting of Tampa, Fla. His e-mail address is bsiegel@tampabay.rr.com. ********** Even people in robust health, faced with the variety of tax-favored health spending accounts now available, can find the whirl of regulations and tax considerations dizzying. Three types of employer-sponsored plans offer tax advantages for out-of-pocket or other medical costs: flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs) and health savings accounts (HSAs). Many employees, self-employed people and small business owners will turn to CPAs to sort out each plan's intricacies and help them tailor one to their needs and resources. The good news: While income tax deductions for health care expenses may be limited by itemization thresholds or the AMT, contributions to health spending accounts generally are excluded from taxable income. Employees may use pretax dollars to make medical-care-related contributions, and self-employed individuals are permitted to take a deduction for health insurance premiums or arrangements having the same effect. FLEXIBLE SPENDING ARRANGEMENTS FSAs are savings accounts funded from pretax earnings that people can use to pay qualified medical expenses. Contributions to FSAs (also commonly known as flexible spending accounts and alternately available to cover dependent care costs) typically are made through salary reduction. Distributions to reimburse employees for qualified medical expenses are excluded from their income. Unlike an HSA (discussed below) an FSA need not be accompanied by a high-deductible health plan (HDHP) or other insurance. FSAs are subject to cafeteria plan regulations, which include a use-it-or-lose-it rule, so an account balance must be spent by the end of each plan year. Starting in 2005, however, the IRS authorized employers to amend their cafeteria plans to allow an optional 2 1/2-month grace period for expenses incurred after the end of the plan year. Therefore, advise your clients to base the amount they elect to have deducted from their pay on an annual budget of likely out-of-pocket expenses. These can include insurance deductibles and copays and even some over-the-counter medications and health supplies. Because an FSA is considered a group health plan under COBRA and the Health Insurance Portability and Accountability Act of 1996 (HIPAA), though, it is not subject to use-it-or-lose-it in some circumstances. For example, under COBRA continuation-of-benefit rules, recently terminated employees may keep paying into their accounts. Although they must do so with after-tax dollars, the extension allows extra time to spend an accumulated balance that would otherwise be lost. …