Knowing about medical savings accounts is key to health insurance decisions

There seems to be no end to ever-rising health insurance costs that consume more and more of our paychecks every year. And as premiums rise many policies cover less by requiring ever-larger deductibles - the amount of money that must be paid out-of-pocket before the carrier steps in to help pay the bills.

Two types of tax-friendly accounts for medical care can help a little, but health savings accounts and flexible spending accounts have important differences, risks and benefits.

Both HSAs and FSAs allow employees to use pre-tax money to pay for health care services beyond the premiums paid for insurance. Both also benefit employers, because employers don't have to pay the payroll tax on compensation workers direct to those accounts.

HSAs are one of those federal tax provisions that primarily help the wealthy, but also offer benefits to the less-affluent. They help the wealthy more because the higher one's income tax rate, the more one saves by avoiding taxation, and because higher earners are more likely to have money to sock away in an HSA.

An HSA is sort of like a 401k or traditional IRA but for health care. The pre-tax contributions escape taxation, the money can be invested and it's not taxed when withdrawn for qualifying medical expenses. Someone could put money in an HSA during their peak earning years, invest the money in stocks and bonds, and withdraw the money tax-free in retirement to pay health care bills.

Unlike retirement plans, qualifying HSA contributions are also exempt from payroll tax - the 7.65 percent rate employees and employers each pay to fund Social Security and Medicare. That's the "FICA" that appears on paycheck stubs.

So, when employees direct some of their pay to an HSA, the money isn't subject to federal or state income tax, or FICA. That means putting $1,000 into an HSA might really cost an employee less than $750 - the amount that $1,000 would have been after taxes, depending on their state and federal rates.

To have such a tax-advantaged HSA an employee must first have an employer that offers a qualifying high-deductible health plan. For 2022, the government defines a high deductible as at least $1,400 for an individual or $2,800 for a family.

With an HSA, an employee could contribute up to $3,650 in 2022, or $7,300 if they have family coverage, plus another $1,000 if they are 55 or older.

The FSA model is different from an HSA in some important ways, but primarily because FSA funds are forfeited if they aren't used, usually within a calendar year. Employees get similar tax advantages, but must be careful to not contribute more to an FSA than they are certain to use during the year.

Left over money in an FSA is kept by the employer. Clearly, employers have incentives to encourage the use of both FSA and HSA accounts, but employees have incentives as well.

Using pre-tax money to pay for health care expenses is a clear and substantial savings. An FSA can also be established for dependent care expenses, offering potentially substantial tax savings to parents.

One more thing to be aware of is that contributing money to an FSA or an HSA reduces future Social Security benefits, particularly for lower-wage workers. That's because contributing money to either account means those funds aren't subject to the tax that funds Social Security and are not counted in the wage calculations that eventually determine the size of one's Social Security checks.