What's an FSA, HSA, 529? How they work and how to use them to cut taxes, build wealth.

Medora Lee, USA TODAY
7 min read
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Health care and education expenses are unavoidable for most Americans, but there are ways to make sure your money’s not just taking a one-way trip out of your pocket.

Health savings accounts, or HSAs, flexible spending accounts, or FSAs and 529 education savings plans help you lower your annual tax bill since they’re all tax-advantaged.  Also, if used strategically, HSAs and 529s can even help you build wealth.

We’ll go over each one and explain how to maximize them to get your bills paid, save money and maybe even earn a little extra income.

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What is the difference between an HSA and FSA?

  • An HSA is a type of savings account that lets you set aside money on a pretax basis to pay for medical expenses such as deductibles, copayments and coinsurance. You can only contribute to one if you have a high-deductible health plan, which generally only covers preventive services before the deductible.

The minimum deductible for an HSA in 2022 was $1,400 for an individual and $2,800 for a family. Maximum annual contributions were up to $3,650 for self-only coverage and up to $7,300 for family coverage. If you’re 55 years and older, you can contribute an additional $1,000.

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Unused money can be rolled over each year and invested in stocks, bonds, mutual funds and more, much like growing your money in a retirement fund. Any withdrawals for qualified expenses aren’t taxed. Withdrawals for unqualified expenses incur a 20% penalty and income tax until you’re 65 years old. At that age, the penalty is dropped.

A flexible spending account is a savings account of pretax money that you use to pay for certain out-of-pocket health care expenses.
A flexible spending account is a savings account of pretax money that you use to pay for certain out-of-pocket health care expenses.

  • An FSA is a savings account of pretax money that you use to pay for certain out-of-pocket health care expenses. FSAs predated HSAs and are less flexible.

In 2023, employees can contribute up to $3,050, from $2,850 last year. If the employer's plan permits the carryover of unused health FSA amounts, the maximum carryover amount rises to $610, up from $570.

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How can I maximize an HSA?

  • Contribute as much tax-free money as you can into your HSA to lower your taxable income.

With the limits, “it doesn't seem like a lot, but if you do it for 30 years, it becomes a good amount of money,” said Jaime Eckels, wealth management partner at certified public accountant Plante Moran.  

  • Invest your contributions and watch that money grow. 

  • If you suddenly find yourself in a financial bind, you can withdraw money tax-free against any receipts for qualified expenses you paid for out of pocket while your HSA was invested and growing.

“There’s no timeline of when an HSA account holder has to reimburse themselves,” said Ryan Losi, executive vice president at CPA firm PIASCIK. “You can accumulate medical expenses, create a folder over 40 years and put in all the documents for them; meantime, pay out of pocket, then at 65 (years) you can reimburse self-tax free.”

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Once in your lifetime, you can roll money in your IRA into an HSA using what’s called a qualified health funding distribution.
Once in your lifetime, you can roll money in your IRA into an HSA using what’s called a qualified health funding distribution.

What is the benefit of an FSA? And the disadvantage?

  • Con: if you don’t use all your money, you lose it at yearend (though some companies give you a 2.5-month grace period to drain the account).

“Don’t overestimate what you think you’ll spend because of the use or lose it,” said Leslie Thompson, chief investment officer and co-founder of Spectrum Wealth Management. “There’s no savings mechanism to it.”

  • Pro: Contributions are pretax, lowering your taxable income.

  • Pro: the 2020 CARES Act expanded eligible items FSA (and HSA) funds could be used to purchase. You can now buy over-the-counter drugs such as cold medicines, anti-inflammatories and allergy medicine. Additionally, menstrual care products, crutches, diagnostic devices, Band-Aids, sunscreen with SPF 15 or higher, vitamins, and more, qualify. For more details, check the IRS guidelines or FSAstore.com, said Eckels.

“If you have to, you can load up your medicine cabinet to use up your dollars,” she said.

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What is a 529 plan and how does it work?

It’s a state-sponsored investment plan that allows you to save money to pay for education expenses. Investment options vary from plan to plan but typically are in stocks and bonds.

Contributions are made with after-tax dollars, but earnings grow tax-deferred and withdrawals are free of federal income tax when used for qualified education expenses, including books, K-12 or college tuition, room and board, and fees. Some states offer full or partial deductions for contributions.

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How can I maximize a 529 plan?

  • Get a state income tax deduction for your contributions, depending on where you live and what plan you choose, that can trim your tax bill.

  • Start early and let that money grow. By the time you’re ready to spend it, the amount saved could be substantial.

  • Money withdrawn is tax-free for qualified expenses.

  • Starting in 2024, you can begin rolling a lifetime maximum of $35,000 tax-free into a Roth IRA, thanks to last year’s Secure Act 2.0, if you think all the money won’t be spent. The amount is also subject to annual Roth IRA limits. The contribution limit for 2023 is set at $6,500, with an extra $1,000 catch-up allowance for people over 50. 

Assume you’ve rolled over the lifetime cap of $35,000 from the 529 into the Roth IRA by the time your kid graduates from college at age 22. By the time your kid reaches 67, retirement age, that amount will have grown to $1.6 million, based on 9% annual compound growth (the S&P 500 historically has returned around 10% each year).

  • Contribute five years' worth of contributions at once, if you can, to get money out of your estate to avoid estate tax on the amount.

Former President Barack Obama and his wife contributed a total of $240,000 in 529 savings plans for their two daughters in 2007. That year, the annual gift tax exclusion was $12,000 so each of the parents funded $60,000 (5 years x $12,000) to each daughter and avoided tax on the amounts without dipping into their lifetime gift tax exemptions, which is separate from what you can give away tax-free each year.

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Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at [email protected] and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.   

This article originally appeared on USA TODAY: How HSAs, FSAs, 529s can cut your taxes, pay expenses and grow savings

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