How Your Health Benefits Affect Your Taxes

Your health accounts and medical expenses are probably a large component on your financial radar – it’s important to know the ins and outs to ensure you are taking advantage of what’s offered to you and how this affects your taxes. From account types to deductions, read below and make informed decisions on your health situation.

Different Types of Accounts

Three of the common accounts with tax advantages are HSA (health savings accounts), FSA (health flexible spending accounts), and HRA (health reimbursement arrangements). HSA’s are set up on your own, easily done with a trusted bank. This is an attractive option because your employment doesn’t necessarily affect it, however, both you and potentially your employer contribute to the account throughout the year. The only requirement is that you must have a HDHP (high deductible health plan) in order to have an HSA. An HRA on the other hand, is set up, owned, and contributed to by your employer only. An FSA functions like an HRA, but if can be funded by you and your employer. You can earn interest on money in your HSA, but not on the others.

Taxable Withdrawals

As far as taxable withdrawals go, an HSA wins by a landslide. You can accumulate a sizeable lump sum and take it out as taxable income after retirement, which therefore functions similar to an IRA. However, you must use these funds for healthcare expenses. The same rule goes for FSAs.

HRA balances can be added year by year, but this often comes with a limit by your employer. After employment, they no longer contribute and denies access during retirement, although some employers allow it. As for FSAs, the accounts typically expire the day you are no longer employed with the employer that hosts the account.

Due to each accounts’ above guidelines and restrictions, FSAs and HRAs are deemed as ‘use or lose it’ accounts. Some people realize this and spend their dollars on healthcare expenses like upgrading their glasses before time’s up on December 31st. This downfall is the reason why HSAs are attractive – you can use the funds when a medical emergency arises and the funds are needed.

How Health Accounts Save Taxes

All accounts are great for taxes. When you make qualified contributions to any of them, you can take a deduction for the amount of the contribution, or the contributions can reduce taxable income. The qualified contributions of your employer are not taxable and neither are your withdrawals, given they are spent on qualified medical expenses.

Alternative: Tax Deductions

An alternative to a health account is simply paying for medical expenses with after-tax dollars and take deductions. However, the limitations of that are unattractive. You can only deduct medical expenses after they exceed 10% of your adjusted gross income, or 7.5% if you or your spouse is 65 or older. That typically means most or all of your deduction, not making the small pay off worth it. That’s where health accounts come in for medical expenses.

With the knowledge of the different types of ways to approach your medical expenses and the variety of accounts you can open, consult a tax professional on which particular account works best for your financial situation. Coupled with your health insurance, one of these accounts can significantly help your taxes.

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