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What is a tax-advantaged benefits account?
Simply put, a tax-advantaged benefits account is an account that lets you save pre-tax money from your paycheck for IRS-qualified out-of-pocket health expenses, such as copays, hospital stays, prescription drugs, and more. Nextep offers a variety of options:
Flexible Spending Account (FSA)
An FSA helps with out-of-pocket health expenses not covered by insurance. Employees can set aside money from their paychecks that go directly into their FSA and then redeem it by paying for health expenses with a special debit card at the point of sale or via reimbursement.
Each year, you can contribute up to an amount determined by the IRS. Plan carefully, though; your annual contribution is mostly use-it-or-lose-it. You may roll over up to a certain amount of unused funds (e.g., $680 from 2026 funds into 2027) each year. After that, any leftover FSA funds at the end of the grace period (2 1/2 months after the plan year ends) are forfeited.
Tip: If you’re at the end of your plan year’s grace period and still have more funds than you can roll over, shop at The FSA Store. You’ll find various FSA and HSA-eligible items to stock up on.
Health Savings Account (HSA)
An HSA is similar to the FSA in several ways. It allows you to set aside money for qualified out-of-pocket health expenses. It has an annual contribution limit set by the IRS. But there are some key differences.
Unlike the FSA, all unused HSA funds can be rolled over from year to year. In fact, you can take an HSA with you after you leave your company and use those funds well into retirement. Also, you may only contribute to an HSA in conjunction with a high-deductible health plan (HDHP). One purpose of the HSA is to help offset the additional costs of having health insurance with a higher deductible.
Most of our other tax-advantaged benefit accounts can be stacked on top of one another. However, an employee cannot contribute to an FSA and HSA in the same plan year.
Health Reimbursement Arrangement (HRA)
The FSA and HSA are largely employee-funded, though employers can also contribute to those accounts. An HRA, though, is 100% employer-funded.
A health reimbursement arrangement (HRA) is a health plan that the employer owns and contributes to for the benefit of employees. They represent an employer’s commitment to pay for certain health care expenses or offset a portion of the deductible for employees.
Businesses can use HRAs with a high-deductible health plan (HDHP) to control healthcare costs. The savings fund a portion of the employee’s deductible.
Employer reimbursements for qualified expenses are tax deductible for the employer and tax-exempt for employees. Employers can strategize with Nextep’s benefits experts to decide how to structure the plan.
Dependent Care Account (DCA)
A flexible spending account for dependent care (DCA) allows you to set aside funds from your paycheck pre-tax to pay for qualified dependent care expenses.
The DCA covers your children ages 12 and under, a disabled spouse, elderly parent, or other dependent who is mentally or physically incapable of self-care. The dependent must primarily live with you and be unable to care for themself. Dependent care expenses must be work-related; necessary for you/your spouse to work, look for work, or attend school full-time.
Like the FSA, annual DCA contributions are also use it or lose it. Unlike the FSA, you may not roll over a small, set amount of unused funds from one year to the next.
Limited Purpose FSA (LPFSA)
An LPFSA allows you to deduct a set amount of pre-tax money from each paycheck to pay for certain IRS-qualified out-of-pocket dental and vision expenses, such as dental and vision checkups, copays, braces, glasses for you and your dependents, and travel to appointments.
To participate in the LPFSA, you must be enrolled in a high-deductible health plan (HDHP). You may use an LPFSA and HSA concurrently, but you may not use both an LPFSA and FSA in the same plan year.
Parking & Transit FSA
The parking and transit FSAs allow you to set aside pre-tax dollars for IRS-approved parking or mass-transit commuting expenses. Important note: The parking and transit FSAs are for work-related transportation expenses. Parking fees and transportation expenses for medical care can be reimbursed with your FSA or HSA health-related accounts.
You may enroll in one or both FSAs for parking and transit and hold them concurrently with the FSA, LPFSA, DCA, and HSA. Unlike traditional FSAs, the IRS does not have a “use it or lose it” rule for parking or transit FSAs. Any unused funds at the calendar year’s end are rolled over to the next year.
What is an eligible expense?
Since the IRS regulates tax-advantaged benefit plans, the list of eligible expenses is tightly controlled. Below is an example of what is (and is not) eligible. Please see your plan for a complete listing of eligible expenses:
FSA and HSA:
- Ambulance
- Artificial limbs and teeth
- Eye care expenses and materials
- Dental treatment and orthodontia
- Copays and fees to doctors
- Guide dog
- Hospital stays and services
- Prescribed medical supplies and devices
- Lodging & transportation for medical care
- Therapy and mental health inpatient care
- Prescription drugs
- Vaccinations
- X-rays
- Download a detailed list here.
- Not eligible: Supplements, cosmetic or weight-loss procedures that are not medically necessary, gym memberships, marriage counseling, diaper service, and more.
DCA:
- Adult and senior day-care
- Licensed before and after-school programs
- Nanny or work-related babysitting, not by a tax-dependent
- Elder care
- Nursery, preschool, and childcare
- Summer day camp for children
- Not eligible: school tuition & assisted living
LPFSA:
- Non-cosmetic dental & vision office visits, exams, and operations
- Dental X-rays, crowns, fillings, and orthodontia
- Artificial teeth, dentures, and occlusal guards
- Contact lenses, prescription eyeglasses
- Transportation & lodging for dental or vision care
- Lasik eye surgery & radial keratotomy
- Not eligible: Non dental or vision expenses, purely cosmetic procedures or materials
Parking FSA:
- Parking your vehicle at or near your place of employment
- Parking at a location from where you commute, such as a train or bus station lot
- Not eligible: Parking expenses for medical care. Those can be reimbursed with your FSA or HSA health-related accounts.
Transit FSA:
- Transit passes to and from work, including the cost of tokens, passes, fare cards, vouchers
- Tickets or monthly passes for mass transit systems such as trains, buses, and subways
- Transportation via a qualified private transportation company
- Transportation in a commuter highway vehicle
- Qualified bicycle reimbursement
- Not eligible: Transportation expenses for medical care.
How much should I save?
So, how much should you contribute each year to your tax-advantaged benefit account? It is, of course, a personal decision that depends on your family’s expected health expenses and budget.
The most straightforward approach is to think at a base level about the fees and costs of your family’s expected health care for the coming year. Be sure to factor in office visits, copays, X-rays, glasses, braces, prescription drugs, and checkups. If you have an FSA, try to keep your contributions close to what you will actually use in the calendar year since you can only roll over a small amount. Here’s an online calculator to help you calculate your short-term health costs for the year:
If you have an HSA and room in your budget for the deductions, your next level can include a cushion for unexpected health expenses. An ambulance ride, broken limb, or new health condition can significantly add to your health expenses. An HSA can withstand the extra financial padding since it allows you to roll over unused funds from year to year. As we’ll explain in the next section, you can even use your HSA for investment and retirement savings. Here’s an online calculator to help you calculate your long-term health expenses into retirement:
As mentioned, the IRS limits the amount you can contribute to your tax-advantaged accounts each year. If your employer chooses to contribute to your account, subtract that amount from the total you are eligible to contribute. For example, if your employer contributes $500 to your FSA and the IRS-allowed max is $8,550, then you are eligible to contribute up to $8,050 to your FSA each year.
Another nuance to note: Your FSA and HSA maximums are determined by household; not by person. If the IRS maximum is $8,550, for example, and your spouse contributes $5,000 to an HSA that year, you can contribute up to $3,550.
How do tax-advantaged benefit accounts save me money?
The easiest explanation of how these accounts save money is tax savings. Deductions come out of your check pre-tax, and then you withdraw them to pay for eligible expenses without incurring any tax penalties.
Lower taxable wages are an easy benefit, but there are additional benefits when you think long-term. Remember, HSAs allow unlimited rollover of leftover funds, so a surplus could potentially build over time. Through your HSA carrier, you can invest that HSA surplus and then take the money out when you need it without incurring tax penalties. Any investment earnings within your HSA grow tax-free.
You can use your HSA funds for qualified medical expenses throughout your lifetime, including retirement. There is no time limit on when to use your HSA funds. You can even designate a beneficiary to receive the balance of your HSA account in the event of your death.
One optional investment strategy we’ve seen some use is to save money pre-tax to their HSA and invest it for a number of years rather than getting reimbursed for expenses. They continue to pay health expenses out of pocket (post-tax). Then, they’ll have a higher HSA balance to pay for health expenses during retirement since the saved funds will have earned interest while invested.
Though you have to participate in a qualified high-deductible health plan (HDHP) to make HSA contributions, you don’t have to be on the plan to withdraw the funds for qualified health expenses, even if you’re not under a high-deductible health plan. Therefore, a retired person on Medicare could still use their HSA for eligible expenses.
8 ways to save on health costs
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Now that you’re a tax-advantaged benefit account expert, you can review your options and decide if one or more are the right fit for your family. If you have any questions, contact our benefits experts at Nextep.
