By Sharita Hutton
When it comes to tax-deferred accounts for health expenses, most taxpayers get it all wrong. A recent Fidelity survey shows that nearly 3 in 4 incorrectly think employer-provided health savings accounts and flexible spending accounts are virtually the same thing. H&R Block (NYSE: HRB) knows this misunderstanding causes many to miss out on a chance to pay less in taxes because contributions to these accounts are not taxed. Before checking off the same boxes they do every year during open enrollment for health benefits at work, taxpayers who have access should consider these accounts.
How much money? A $2,000 annual ($166 monthly) contribution to health savings account or a flexible spending account could save a taxpayer in the 25-percent tax bracket $500 in taxes (contribution à marginal tax rate = tax savings).
The money contributed to either type of account must be spent on qualified medical expenses, which include eyeglasses, contact lenses and prescribed medication. Also, appointments with doctors  for general preventative checkups, appointments with specialists and visits when not feeling well  are among the eligible expenses. All these routine expenses can add up quickly; out-of-pocket costs for a family of four were expected to average $3,600 in 2013, according to the 2013 Milliman Medical Index.
Not going to the doctor when sick could save money, just like wearing outdated prescription glasses and only taking half as much medication as prescribed, but none of these are advisable ways to save on health care expenses. Here is some information taxpayers can use to determine if a health savings account or a flexible spending account could help them save money.
Health savings account gives opportunity for long-term saving
As with other savings accounts, the money in a health savings account can stay in the account indefinitely, allowing the account holder to save for future medical needs. Funds used for qualified expenses can be withdrawn tax-free, and interest earned on the account is tax-exempt. Here are some of the participation rules:
The taxpayer must participate in a high-deductible health plan
- High-deductible is defined as at least $1,250 deductible for self-only coverage and $2,500 for a family
- Plan must not pay benefits until deductible is reached
(There are exceptions for preventive care and certain permitted benefits, such as dental expenses)
The maximum contribution for 2014 is $3,300 for self-only coverage and $6,550 for a family
- An additional $1,000 may be contributed for taxpayers who are at least 55 years old.
Flexible spending account money must be used by deadline or it will be lost.
Unlike with health savings accounts, the money contributed to a flexible spending account must be used by the end of the plan year or grace period, or it will be lost. Up to $2,500 may be withheld from gross income for contributions to flexible spending accounts.
Just like other elections made during open enrollment for benefits, decisions about these accounts cannot be changed before the next annual enrollment period, unless an employee has a qualifying event. Among qualifying events are birth, divorce, marriage, death and loss of benefits from another source (e.g., a spouse losing a job).
Some retirement options selected during open enrollment also have pre-tax benefits
Another option for pre-tax savings that happens as part of open enrollment in the workplace is selecting retirement savings plans. The average retirement span is 18 years and 80 percent of people ages 30-54 donÂt think they will have enough money put away for their retirement. A good first step in saving for retirement is to make pre-tax contributions to a 401(k). Because these contributions are made with money that has not been taxed, the amount contributed reduces taxable income and that can potentially reduce the overall tax bill. Also, retirement savings grow tax-free.
For more information about health savings accounts and flexible spending accounts, saving for retirement or advice on other ways to reduce tax liability, contact an H&R Block tax professional. To find the nearest H&R Block office, visit www.hrblock.com or call 800-HRBLOCK.
