THERE ARE TWO popular types of tax-favored health care account, and they’re sometimes confused. First, your employer may offer a flexible spending account, or FSA, which you can use to pay for health care expenses—such as deductibles and co-payments—that aren’t covered by your employer’s health plan. These accounts are funded out of pretax income, so you avoid income taxes and payroll taxes on the money involved. Each year, employees commit to funding these accounts up to a dollar amount they choose, though that sum can’t be greater than $2,750 in both 2020 and 2021.
Keep in mind that, with money in these accounts, it’s “use it or lose it.” The accounts typically need to be emptied by Dec. 31, though employers are allowed to offer a grace period that extends until mid-March. Alternatively, employers can stick with the Dec. 31 cutoff but allow employees to roll over as much as $550 from one year to the next. Under legislation passed in late 2020, however, employees have more flexibility when rolling over money in 2020 and 2021. Check with your employer’s human resources department for more details.
What’s the second popular type of account? If you have a high-deductible health insurance policy, you may get the chance to fund a health savings account, or HSA. In 2020 and 2021, to qualify, a plan must have a deductible of at least $1,400 if you’re single and $2,800 if the coverage is for a family. If you have a qualifying plan, you can make tax-deductible contributions in 2020 of as much as $3,550 to an HSA if you’re single and $7,100 if you have a family plan. The 2021 limits are $3,600 for single individuals and $7,200 for families. You can contribute an additional $1,000 if you’re age 55 or older.
Withdrawals used for qualifying medical expenses are tax-free. But every year, unlike an FSA, you don’t need to empty the account largely or entirely. Instead, you can leave the money to grow and use it tax-free for future medical expenses, including medical expenses in retirement.
You can also use the money for other reasons, though you’ll have to pay income taxes on your withdrawals and, if you are under age 65, a 20% tax penalty. Unlike with a traditional IRA or other retirement accounts, you aren’t required to take minimum annual distributions starting at age 72.
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