We all have unexpected medical bills from time to time – dental work that costs more than we planned for, as an example, or surgery like LASIK that isn’t completely covered by insurance. When such things come up we have several options we can use to finance them – deplete our savings, arrange a payment plan, or even, if the procedure is costly enough, take out a loan. There is also another option, one you’ve probably seen in your benefits package from your employer. It’s called a “flexible spending account,” and it’s essentially a reserve account that you keep, that can only be used for health-related expenses.
There are actually three different kinds of health spending accounts. There are the basic flexible spending accounts, there are health reimbursement accounts, and there are medical savings accounts. Here is an overview of each type.
Flexible Spending Accounts
Flexible spending accounts are health care savings accounts that your employer or insurance provider establishes, so that you can be reimbursed for specified medical expenses as they are incurred. These are also known as “cafeteria plans” or “125 plans” because they are governed by section 125 of the Internal Revenue Code.
With one of these accounts, funds are taken from your paycheck each pay period, and you can withdraw them as needed to pay for medical bills. Because of the salary reduction agreement, any money in these accounts are not subject to income or Social Security taxing.
While many employers put a cap of $2,000 or $3,000 on these accounts, there is no statutory limit on the amount that can be contributed. You can even make contributions over and above your payroll deduction, if you know you will have a large expense in the future. However, once the amount of the regular deduction has been selected for a given year, you cannot drop the program, or change your deduction until the next plan year, unless there is a change in your family status.
At the end of the year, any unused money is forfeit.
Health Reimbursement Accounts
Also known as “personal care accounts” and “health reimbursement agreements,” these accounts are a kind of insurance plan that reimburses you for qualified medical expenses. These accounts have only been around since 2002, and guidelines for them are still evolving, but generally they are funds that employers set aside so that you can be reimbursed for medical bills.
These accounts are available to companies of all sizes, and provide “first dollar” coverage until there are no more funds available. “First dollar” means that if you have a medical bill of $475, every dollar of it is covered, as long as there is money in the account. Unlike a flexible spending account, unused money does roll over at the end of the year. As well, while the employer retains control of the account, you can still access your money after you’ve left the company, even if you retired.
Medical Savings Accounts
The third type of health care spending account is a medical savings account. This type of account is used to pay for unreimbursed medical expenses, and unlike the other two account types, they can earn tax-deferred interest.
With a medical savings accounts, you control the funds, and either you or your employer, but never both, makes the contributions. In order to qualify, however, you have to be either self-employed, or employed by a company with fifty or fewer employees, and you have to be covered by an insurance plan with a high deductible. There are both qualifying high deductibles (in 2001 they ranged from $1,600 – $2,400 for self-only, or $3,200 – $4,800 for family coverage) and maximum out-of-pocket expenses ($3,200 for self-only coverage, and $5,850 for family coverage in 2001).
Savings from these accounts do roll over each year, and are also portable, meaning you can take them with you to a new company (as long as it still qualifies). The funds in the account can be used on a pre-tax basis to pay for COBRA premiums, long-term care insurance premiums, and any premiums paid while you are unemployed. As well, the money in these accounts can earn interest which isn’t taxed unless you withdraw funds for non-medical purposes, in which case they are considered taxable income and are subject not only to normal income tax, but also a 15% penalty. (Once you reach the eligibility age for Medicare, or if you become disabled, 15% penalty for non-medical use goes away, but income taxes still apply.)
The maximum contribution you can make in a single year is 65% of the deductible if you are covering only yourself, or 75% of the deductible if your insurance also covers dependents.
Medical savings accounts, health reimbursement accounts and flexible spending accounts may all have different guidelines, but they all provide the same benefit: money you can use for unforeseen medical bills. Make sure your insurance quote includes information on these accounts.