How FSAs and HSAs will change under health care reform

The landmark health care legislation passed in 2010 will have major ramifications for consumers who use FSAs and HSAs to help finance their health care.

In 2011, the penalties for withdrawing money from HSAs for non-medical use (if you're under 65) will double from 10 percent to 20 percent. In addition, neither FSAs nor HSAs can be used to purchase over-the-counter drugs unless by prescription.

What are FSAs and HSAs?

Consumers use FSAs and HSAs to set aside pretax money for health care expenses.

  • FSA stands for flexible spending account. An FSA allows employees to apportion some earnings to pay for expenses like future medical needs, dependent care, orthodontic work and other health-related expenses not completely covered by insurance. The money subtracted from the employee's paycheck for the FSA is free from payroll taxes.
  • Health savings accounts (HSAs) supplement high-deductible health insurance policies by providing the ability to sock away money in a tax-free account to pay for medical expenses. HSA funds can grow over time tax-free and can be used to pay for surgical and medical expenses. If you use the money for non-medical expenses, however, you will have to pay a tax penalty -- which will double in 2011.

The regulations governing both FSAs and HSAs can be complicated. For instance, the penalty for using HSAs for non-medical purposes goes away for people 65 and older.

Key changes under health care reform

  • In 2013, FSA maximum contributions will be capped at $2,500 annually. Before health care reform, there was no cap, although many corporate employers limited contributions to no more than $5,000 a year.
  • Beginning in 2011, HSAs and FSAs no longer can be used to purchase non-prescription medications. According to the IRS, patients must get prescriptions for any over-the-counter drugs that they want an FSA or HSA to cover.
  • Also beginning in 2011, penalties for HSA early withdrawal for non-medical expenses will jump up from 10 percent to 20 percent.Opponents take issue with the decreased flexibility the new rules will impose upon FSAs and HSAs as well as the increased tax penalties. Supporters call the changes minor and argue that the caps imposed on FSAs will affect few families.