As medical costs continue to rise, many people are looking to save money wherever possible. Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) are both tax-advantaged accounts. They can help you save money on qualified medical expenses in the long run. But there are some key differences between HSAs and FSAs that you need to know before you open an account.
HSA vs. FSA Basics
There are some basic facts you need to know to understand the differences between FSAs and HSAs. The big similarity they share is that they are both tax-advantaged accounts. This means you can contribute pre-tax funds and withdraw money tax-free when using it to pay for qualified expenses.
The major difference they have is that an FSA is an employer owned account that pays for short-term expenses. You must use up the FSA funds you contributed by the end of the year.
HSAs are individually owned, and you can use them for short-term expenses, or long-term savings, like retirement.
Types of Accounts
There is only one type of HSA, and its main use is to pay for qualified medical costs at any age.
There are three types of FSAs:
When people use the term “FSA,” they are most often talking about a Healthcare FSA. Healthcare FSAs are for qualified medical expenses. Dependent Care FSAs are for qualified care expenses, like child or adult daycare. Limited Purpose FSAs are only used for qualified dental and vision expenses.
The most important thing to remember is that you cannot contribute to a Healthcare FSA or Dependent Care FSA and an HSA at the same time. But you can have a Limited Purpose FSA and an HSA at the same time.
Use-it-or-lose-it and Rollover Rules
Many people have heard the term “use-it-or-lose-it” from their providers. It’s important to know this rule as you consider the differences between HSAs vs. FSAs.
Only FSAs are subject to use-it-or-lose-it rules, which means that if you don’t use the funds you contribute during the year you lose them. Employers have the choice to allow some of the funds to rollover to the next year (up to $550 from 2020 to 2021). They also have the choice to allow a “grace period” to use funds (until March 15 of the following year). But they are not required to do either of these things. Knowing these deadlines can help save you money from going back to your employer.
HSAs are not subject to any of these restrictions. Because you own your own HSA account, those funds never expire. You can decide to use them all or save them for later, but you won’t ever lose them because a plan year is ending.
HSAs and FSAs both have annual contribution limits. The following table outlines those limits for 2021:
You can make HSA contributions throughout the year, whenever you choose. You can choose to contribute via a payroll deduction, or you can choose to contribute within a lump-sum. When contributing via a payroll deduction, you will contribute pre-tax. This helps reduce your taxable income. When you contribute via a lump sum after-tax, those funds are tax-deductible.
For FSAs, you can only decide on how much you contribute at the beginning of the plan year (unless you experience a qualifying life event). This means you must decide how much you want to contribute monthly from the start. You can't raise or lower the amount later in the year.
You can use your full FSA contribution amount at any time. This is because your company deducts your FSA funds via payroll throughout the year. So you don’t have to wait until the end of year to max out your spending if you would like.
Eligibility Requirements for Each Account
A common question that many people have is how to choose the right account. Luckily there are eligibility rules about who can have which type of account.
Which account should I choose?
To qualify for an HSA, you must also enroll in a high deductible health plan (HDHP). If you are eligible, you can open an HSA with the provider of your choice. Often times your employer will have an HSA provider for you. In the event you change jobs, you can then choose to switch HSA providers as you are the account owner.
To qualify for an FSA, your employer must offer one as part of their benefits package. You can’t open one on your own. You must decide to enroll during open enrollment and choose how much you want to contribute for the year.
Still can't choose? Your company's health plans and benefit packages can help determine if an HSA or FSA is right for you.
Advantages and Disadvantages of FSAs and HSAs
While it’s likely you’ll only be eligible for either a Healthcare FSA or an HSA, it is still a good idea to take a look at the pros and cons of both types of accounts. This can help you understand how they align with your greater financial goals and help you decide what healthplan to choose.
- Portable account: means you own the account and don’t lose it if you change jobs
- Triple-tax advantage: Contribute funds pre-tax, funds grow pre-tax, withdraw funds pre-tax for qualified expenses
- No use-it-or-lose-it rules: Spend now or save for retirement.
- Anybody can contribute to your HSA: This includes your employer, spouse, family, or friends, as long as you don’t go over the annual contribution limit.
- Must enroll in a HDHP and meet other qualifications to have one
- May be subject to fees from the provider
- If you use your HSA for non-qualified expenses over age 65 you'll owe an additional 20% tax penalty on top of any taxes due
Healthcare FSA Advantages
- Double tax savings: Contribute funds pre-tax, withdraw funds pre-tax for qualified expenses
- Health plan agnostic: Can enroll in one if your employer offers it, do not need to have a specific type of health insurance plan
Healthcare FSA Disadvantages
- Only available from an employer, can’t have one if you are self-employed
- Employer owned, means you lose the account if you change jobs
- Subject to use-it-or-lose-it rules, meaning you lose funds if you they are not used during the plan year
Align Your Goals with Your Savings
FSAs and HSAs can both play a major role in being able to save money for healthcare expenses. If your employer offers an FSA, and you know you’ll have some qualified expenses in the plan year, it could be a good option for you. If you are enrolled in a HDHP and want a great way to save for planned expenses and retirement, an HSA could be a good option for you.
No matter which you choose, it is always smart to plan out your spending and savings appropriately so you can reach your financial goals.
Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.