Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) offer significant benefits for managing healthcare expenses. These accounts allow you to set aside pre-tax dollars for qualified medical expenses, providing both short- and long-term financial relief. However, many people make common mistakes when using their HSAs and FSAs, which can lead to lost savings, tax penalties, or unmet medical needs.
1. Failing to Understand Eligible Expenses
One of the most common mistakes people make with HSAs and FSAs is not understanding what qualifies as an eligible expense. Each account has specific rules about what can and cannot be paid for using funds, and misusing the accounts for non-qualified expenses can lead to penalties.
For example, while prescription medications are typically eligible expenses, over-the-counter medications may require a prescription to qualify. Cosmetic treatments like Botox or elective procedures like breast augmentation generally don’t qualify unless they are medically necessary. It’s important to consult the IRS guidelines or your account administrator to confirm whether a specific expense is eligible.
To avoid this mistake, keep a detailed list of qualifying expenses and regularly check the IRS list of eligible expenses for HSAs and FSAs. When in doubt, ask your healthcare provider or tax professional to confirm if an expense is eligible.
2. Not Contributing the Maximum Amount
Both HSAs and FSAs have contribution limits that vary each year, but many people fail to take full advantage of these limits. By not contributing the maximum allowable amount, you miss out on the tax benefits that come with using these accounts. In the case of an HSA, contributions are tax-deductible, reducing your taxable income for the year. If you don’t contribute the full amount, you are leaving money on the table in terms of tax savings.
For 2024, the contribution limit for an HSA is $3,850 for individuals and $7,750 for families. FSAs, on the other hand, have a contribution limit of $3,050 per year for individuals. By contributing the maximum allowed, you reduce your taxable income and increase your healthcare savings potential. Additionally, some employers offer a matching contribution, which is free money you shouldn’t pass up.
3. Forgetting About the “Use-It-or-Lose-It” Rule (For FSAs)
One of the biggest pitfalls for FSA holders is the “use-it-or-lose-it” rule, which means that any funds left in your FSA at the end of the plan year are forfeited. This can be a significant disadvantage for those who overestimate their healthcare expenses and fail to use all the funds in their FSA. While some employers offer a grace period or allow a small rollover, it’s crucial to carefully plan your contributions to avoid wasting money.
To avoid this mistake, review your expected medical expenses for the year and contribute only what you believe you will spend. If you have leftover funds, you may want to consider scheduling medical appointments or buying healthcare products before the deadline to use up the remaining balance.
4. Not Investing HSA Funds
Unlike FSAs, HSAs allow unused funds to roll over year after year, creating the opportunity to build long-term savings. However, many individuals fail to take full advantage of this feature by not investing their HSA funds. HSAs can be used for retirement planning because they allow for tax-free growth on investments, similar to retirement accounts like 401(k)s or IRAs.
When you don’t invest your HSA funds, you miss out on potential growth. While your HSA might offer an interest rate on the balance, it’s usually much lower than what you could earn through investments. By investing your HSA funds in mutual funds, stocks, or bonds, you can grow your account over time, creating a significant healthcare nest egg for retirement.
To avoid missing out, consider allocating some of your HSA funds into investment options once your account balance exceeds a certain threshold. This will allow your savings to grow over time and better prepare you for future medical expenses.
5. Not Keeping Track of Receipts and Documentation
Another common mistake when using HSAs and FSAs is failing to keep detailed records of your expenses. If you ever need to prove that you’ve used your account for qualified medical expenses, not having the necessary receipts or documentation can create problems. Both HSAs and FSAs require you to keep proof of eligible expenses, and you may be asked to submit these receipts if you are audited or if your account administrator requests verification.
To avoid issues, always keep your receipts and any relevant documentation for every medical purchase you make. You can even create a digital filing system to organize and store your receipts electronically. This way, if you are ever audited or questioned about your expenses, you’ll have all the information you need.
6. Not Using the HSA for Retirement Healthcare Costs
Many people treat their HSA as a short-term account for paying current medical expenses. While this is one of its key functions, HSAs are also excellent vehicles for retirement healthcare savings. After the age of 65, you can use HSA funds for any expense, not just medical ones, without facing a penalty (though income tax will apply for non-medical withdrawals). However, if you use your HSA funds for medical expenses, the withdrawals remain tax-free.
To maximize the benefits of your HSA, consider treating it as a long-term savings account. Use other funds to cover your healthcare expenses while allowing your HSA to grow for future healthcare needs, especially as you approach retirement.
Conclusion
HSAs and FSAs are powerful tools for managing healthcare costs, but to make the most of them, you need to avoid common mistakes. By understanding eligible expenses, contributing the maximum amount, investing your HSA funds, and keeping detailed records, you can ensure that these accounts work to your advantage. Properly using your HSA or FSA for healthcare costs not only helps reduce your tax burden but also prepares you for future healthcare needs, offering both short- and long-term financial relief.