When it comes to health benefits, it may seem like there is a never-ending list of acronyms to understand. Let's focus on a couple of tax-advantaged savings accounts: Health Savings Accounts (HSA) and Flexible Spending Accounts (FSA). What do FSAs and HSAs have in common, and how they are different?
What HSAs and FSAs Have in Common
1) They are both tax-advantaged accounts
When you contribute to an HSA or FSA, you deposit funds pre-tax. This means you don’t pay federal income taxes on the contributions you or your employer make. Depending on where you live, you may have to pay state taxes on contributions. Having a tax-advantaged account like this can help you save up to 30% on qualifying medical expenses, depending on your tax bracket.
2) Both HSAs and FSAs can be offered as an employer benefit at the same time
Many employers offer the option to contribute to either an HSA or healthcare FSA. These benefits are often paired with an employer-sponsored health care plan.
3) Both you and your employer can contribute to your HSA and FSA
Employers who offer an HSA or FSA may also offer to contribute to an employee's account. This is not mandatory for employers. But, if they do, the employee will not pay federal income taxes on that money.
4) Contributions to HSAs and FSAs can only be used for specific purchases
The rules vary depending on the type of account you have. Limited Purpose FSAs allow you to pay for out-of-pocket dental and vision costs. And Dependent Care FSAs allow you to use your savings to pay for child or adult daycare expenses.
You can learn more about account rules below:
- Health Savings Account (HSA)
- Healthcare Flexible Spending Account (FSA)
- Limited Purpose Flexible Spending Account (LPFSA)
- Dependent Care FSA (DPFSA)
You can use your HSA and FSA to pay for you, your spouse, and your dependents
This includes children until they turn 26 years of age, and parents who are under your full-time care.
The Differences Between HSAs and FSAs
1) How You Qualify
To qualify for an FSA, your employer must offer this type of account. This means that FSAs aren't available in the private healthcare marketplace. The upside is that you can pair an FSA with any type of health insurance plan or no plan at all. It’s your choice.
If both you and your spouse's employer offers an FSA, both of you can contribute up to the maximum contribution limit.
The qualifying rules for HSAs are a little more strict. To qualify for an HSA, you must enroll in a High-Deductible Health Plan (HDHP).
This means your health insurance deductible is at least $1,400 for an individual plan and $2,800 for a family plan. And not covered by any other insurance (as of 2020). That means no dual coverage under a spouse’s plan.
Two other restrictions that can bar you from opening an HSA: 1) qualifying for Medicare, and 2) being considered a dependent on someone else's tax return.
The upside to HSAs is that you can open an HSA in the private market as long as you meet the above requirements. Meaning, if your employer offers an HDHP but not an HSA, or if you buy an HDHP in the private marketplace, you can still open this type of savings account.
2) Account Ownership
If you’ve opened an HSA, you own it. Even if your employer has contributed to it. That means if you leave your employer for any reason, you take the money with you. Even if you retire from the workforce completely.
If you’ve opened an FSA, your employer owns it. Even if the contributions made into that account are from your paycheck. That means that if you leave your employer for any reason, your employer gets to keep the money left in your FSA unless you’re eligible to keep it under COBRA.
Since you own your HSA, you get to take it with you from employer-to-employer (or employer to unemployed). Even if you choose a PPO at your next job (instead of an HDHP), you can continue to use your contributions to pay for qualified medical expenses. You won't be able to contribute to your HSA again until you also enroll in a qualifying health plan.
FSAs are not portable since your employer owns your account. You might be able to continue using the contributions you’ve already made if you lose your job and qualify to keep your FSA under COBRA. But, you won’t be able to continue contributing to the account and you will give up any unused money once your COBRA benefits stop.
4) How They Function
If you have an employer-sponsored HSA, you will fund it by choosing your annual contribution amount during open enrollment. Your employer will then take the appropriate amount from your paycheck each month. If you’ve opened your HSA in the private marketplace, you can choose to have an amount withdrawn from your checking account each month.
You can change your contribution amount at any time and only have access to the funds currently in your account (not future pledged contributions). If you have an HSA, you likely have two options to pay for your medical expenses. Either via a debit card linked to your HSA account or you can pay for the expenses and submit documentation for reimbursement.
If you have an FSA, you will choose your annual contribution amount during open enrollment. Then, your employer will take the appropriate amount out of your paycheck each month and allocate the funds to your account. You can only change the amount you contribute outside of open enrollment if you’ve experienced a qualifying life event. These events include marriage, the birth of a child, the death of a dependent, among others.
Your employer may choose to frontload your FSA with the total annual amount you’ve pledged. This provides you access to your funds right away in the case of an emergency. FSA funds are distributed via reimbursement. You pay for the expenses first, then submit the proper documentation for reimbursement.
5) Contribution Limits
Contribution limits for HSAs are governed by the type of health plan the account owner has. So if you have an HSA and an individual HDHP health insurance plan, your maximum hsa contribution limit is $3,550 for 2020. If you have a family plan, your maximum contribution limit is $7,100.
If both you and your spouse are covered under one family HDHP, but you each have the option to open an HSA with your respective employers, the total amount you contribute cannot exceed $7,100. If you or your spouse are over the age of 55, you can contribute an additional $1,000 per year.
Conversely, contribution limits for FSAs are governed on a per-account basis. That means each FSA owner can only contribute up to $2,750 in 2020. This is regardless of whether they have an individual or family health plan. But if you and your spouse are offered the option to open an FSA through your respective employers, you can each contribute up to $2,750 for 2020.
Part of the functionality of HSAs being portable and owned by the beneficiary is that you never lose your contributions or those of your employer. Even when you retire. Which means you can use your HSA as a type of retirement account.
FSAs have a “use it or lose it” rule. That means you lose any unused funds at the end of the year. The caveat is that your employer may offer one of two allowances. Either a 2.5 month grace period following the end of the plan year, during which you can use your leftover money, or a $500 rollover.
Both HSAs and FSAs give you a tax-advantaged way to save for out-of-pocket medical and dental expenses. Or dependent care expenses in the case of a dependent care FSA. But the rules for each account are different. When choosing an HSA or FSA for you and your family, consider which account, or combination of accounts, will better serve you best.
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.