Being able to use pretax money means healthcare dollars go farther and it lessens taxable income. If you live in a high-tax state and make $100,000, you can easily have a combined income tax rate of 35%, so tax savings are big.

The wrinkle: While day-care costs are knowable, figuring out how much to save in a healthcare FSA is tricky. With both accounts, you’re stuck with the dollar amount you choose unless you have a major life event like getting married or having a child, and if you don’t use all the money, you lose it.

If a big dental expense is coming up, putting the maximum amount in a healthcare FSA makes sense. But money in health-care and dependent-care FSAs generally has to be used within the year. The average FSA forfeiture amount in 2019 was $369, according to an Employee Benefit Research Institute database.

Health Savings Accounts (HSAs)

The basics: If you’re in a high-deductible health-care plan, you’re likely eligible for a health savings account. HSAs let individuals contribute as much as $3,850 in pretax funds, or $7,750 for family coverage; employees over 55 can contribute an additional $1,000 a year. The money can be deducted from paychecks or contributed post-tax (and deducted on tax returns), and used for an array of medical expenses.

HSAs can be invested in mutual funds and grow tax-free, and money used for medical costs remains untaxed. HSAs are portable — you don’t lose them if you leave your job, and unused money rolls over and is available for future years. (Users of HSAs can’t have health-care FSAs, but can open limited-purpose FSAs for vision and dental expenses.)

For well-paid clients in high-tax states, “my advice skews to getting every bit of tax juice that you can from benefits, which generally means maxing out your HSA,” said wealth adviser Rachel Elson, who works in the San Francisco office of Perigon Wealth Management. “We also encourage people to cover health-care expenses with cash flow to the extent they can, and let HSAs be invested and grow.”

The wrinkle: You need good cash flow to pay medical expenses out of pocket. If you use HSAs for anything but qualified medical expenses before age 65, you pay a 20% penalty and income tax. Once you’re eligible for Medicare, the 20% penalty goes away, though you’ll pay income tax on amounts used for non-medical expenses.

This article was provided by Bloomberg News.

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