Health and education expenses are unavoidable for most Americans, but there are ways to make sure your money doesn’t just make a one-way trip out of your pocket.
Health Savings Accounts (HSA), Flexible Spending Accounts (FSA) and 529 college savings plans help you lower your annual tax bill since they are all tax-efficient. Plus, if used strategically, HSAs and 529s can even help you build wealth.
We’ll go over each one and tell you how to maximize them to get your bills paid, save some cash, and maybe even earn a little extra income.
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What is the difference between an HSA and an FSA?
- HSA is a type of savings account that allows you to set aside pre-tax money to pay for medical expenses such as deductibles, co-payments and coinsurance. You can only contribute if you have a high-deductible health plan, which usually 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 personal coverage and up to $7,300 for family coverage. If you are 55 or 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. Withdrawals for qualifying expenses are not taxed. Withdrawals for ineligible expenses result in a 20% penalty and income tax until age 65. At this age, the penalty is lifted.
- FSA is a pre-tax money savings account that you use to pay for certain out-of-pocket health expenses. FSAs predate HSAs and are less flexible.
In 2023, employees can contribute up to $3,050, up from $2,850 last year. If the employer plan allows carryover of unused Health FSA amounts, the maximum carryover amount increases to $610, from $570 previously.
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How can I maximize an HSA?
- Contribute as much tax-free money as you can in your HSA to reduce your taxable income.
With the limits, “that 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 CPA Plante. Moran.
- Invest your contributions and watch that money grow.
- If you suddenly find yourself in a difficult financial situation, you can withdraw money tax-free against any receipt for eligible expenses. you paid out of pocket while your HSA was invested and growing.
“There is no timeline for when an HSA account holder is due for reimbursement,” said Ryan Losi, executive vice president of CPA PIASCIK. “You can accumulate medical expenses, create a 40-year file and put all the necessary documents in it; in the meantime, pay out of pocket, then at 65 (years) you can repay yourself tax-free.
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What is the benefit of an FSA? And the downside?
- Con: if you don’t use all your money, you lose it at the end of the year (although some companies give you a grace period of 2.5 months to empty the account).
“Don’t overestimate what you think you’re spending due to use or loss,” said Leslie Thompson, chief investment officer and co-founder of Spectrum Wealth Management. “There is no savings mechanism for this.”
- Pro: Contributions are before tax, which reduces your taxable income.
- Pro: The CARES Act of 2020 expanded the eligible items that FSA (and HSA) funds could be used to purchase. You can now buy over-the-counter medications such as cold medicine, anti-inflammatories, and allergy medicine. Additionally, menstrual care products, crutches, diagnostic devices, bandages, sunscreen with SPF 15 or higher, vitamins, etc. are eligible. For more details, see the IRS Guidelines Or FSAstore.comEckels said.
“If you have to, you can fill your medicine cabinet to use your money,” she said.
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What is a 529 plan and how does it work?
It is a state-sponsored investment plan that allows you to save money to pay for your education costs. Investment options vary from plan to plan, but are generally in stocks and bonds.
Contributions are made with after-tax dollars, but earnings grow tax-deferred, and withdrawals are exempt from federal income tax when used for qualified educational 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?
- Take a state income tax deduction for your contributionsdepending on where you live and the plan you choose, this can lower your tax bill.
- Start early and let that money grow. By the time you are ready to spend it, the amount saved could be substantial.
- Money withdrawn is tax-free for qualifying expenses.
- From 2024 you can start roll 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 Roth IRA annual limits. The contribution limit for 2023 is set at $6,500, with an additional catch-up allowance of $1,000 for people over 50.
Let’s say you’ve exceeded the $35,000 lifetime cap on the 529 Roth IRA by the time your child graduates from college at age 22. By the time your child reaches retirement age 67, that amount will have grown to $1.6 million, based on compound annual growth of 9% (the S&P 500 has historically returned about 10% every year).
- Contribute five years of contributions at a time, if you canto withdraw money from your estate to avoid inheritance tax on the amount.
Former President Barack Obama and his wife contributed a total of $240,000 to 529 savings plans for their two daughters in 2007. That year, the annual gift tax exclusion was $12,000. $, so that each parent has funded $60,000 (5 years x $12,000) to each daughter and avoid tax on the amounts without tapping into their lifetime gift tax exemptions, which are separate from what you can donate 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 mjlee@usatoday.com and sign up for our free Daily Money newsletter for personal finance tips and business news Monday through Friday mornings.