Lower Your Tax Bill with 401(k)s, HSAs and FSAs

tax breaks, health care | November 17, 2015 | By Bobby Willover

tax savings with 401(k)s, HSAs, FSAs

The end of 2015 is getting closer every day and now’s the time to start planning how to cut your tax bill for 2016. You have several ways, but one of the best is to take advantage of tax-friendly savings and spending accounts like a 401(k), Flexible Spending Account (FSA), or Health Savings Account (HSA). Contributing to these accounts helps you save for retirement and pay for healthcare and dependent care expenses. These accounts also provide important tax savings that add up. Let’s break down the benefits and qualifications for each account.

A 401(k) is an employer-sponsored retirement savings plan where contributions are tax-deferred. This means that you don’t pay taxes on the funds until you withdraw the money later in life. For 2016, the contribution limit will be $18,000. If you’re over 50, you’re allowed an extra $6,000 as a catch-up contribution. All contributions made through payroll deduction or through your employer are pre-tax dollars, and you can find the amount contributed on Form W-2, box 12. The 401(k) is designed as a retirement savings account; there is a 10% penalty for withdrawing funds before turning 59 and a half. Another reason to consider contributing to a 401(k) is the Saver’s Credit. You might be eligible for this credit, depending on your adjusted gross income. You can find more info here.

FSAs and HSAs are both employer-sponsored and allow you to contribute pre-tax dollars from your wages. There are some key differences between these accounts. Here are key facts about the FSA.

First, there are two types of FSAs: healthcare and dependent care.

  • For 2016, the annual contribution limit to a healthcare FSAs is $2,250. Dependent care FSAs have an annual contribution limit of $5,000 for qualifying individuals and couples who file jointly. If you’re married and file separately, the limit is $2,500.
  • Contributions can be made by both you and your employer, but the dollar limit applies to both of your contributions.
  • An FSA is a “use-it-or-lose-it” account. If you have funds left over at the end of the calendar year, you lose those funds. Starting with 2014, however, the employer can offer a carryover of up to $500, or a grace period of two-and-a-half months to spend the remaining funds. Employers have no obligation to offer these options. If they choose to do so, they can offer either a carryover or a grace period, but not both.
  • There are no reporting requirements for FSAs on your tax return.
  • You can withdraw funds from your FSA to pay for qualified medical expenses even if you haven’t placed the funds in your account. For more info about FSAs, click here.

Now, some details on the HSA:

  • In order to have an HSA, you must have a high-deductible health plan.
  • The annual contribution limit to HSAs for 2016 is $3,350 for individuals and $6,750 for families. If you’re 55 or older, you can contribute up to an additional $1,000 in catch-up contributions.
  • Contributions can be made by both the employee and employer, but the dollar limit applies to both of your contributions.
  • The balance of an HSA can be carried over from year to year and continue to grow tax-deferred. There’s no “use-it-or-lose-it” rule like an FSA. You can invest your HSA money and enjoy tax-free earnings, so long as you use the money to pay for qualified medical expenses. For more info about HSA expenses, click here.
  • You’ll need to include Form 8889 when filing your taxes. This form shows the total amount of contributions and withdrawals. Your direct contributions appear as a deduction on your taxes. Pre-tax contributions made through payroll deduction or by an employer will appear on Form W-2 in box 12.
  • You should also receive Form 1099-SA from your HSA administrator. This form lists all your withdrawals for the year. If you used any funds for nonqualified expenses, you’ll have to pay tax on that amount. You’ll also be subject to a 20% penalty if you’re 65 years old or younger. The burden is on you to prove how you spent the funds, so keep those receipts!

These are some great ways to save for retirement, budget for healthcare and dependent care expenses, and cut down your tax bill. Talk to your employer and find out what options are available to you so that you can make your money go further in 2016.