HSA vs FSA: How to Choose Between an HSA and Healthcare FSA

LinkedIn Icon

An HSA and FSA provide up to 30% savings on out-of-pocket healthcare expenses. But you can’t contribute to both at the same time. Let’s explore each account type to help you decide which wins in HSA vs FSA.

LinkedIn Icon

Editor’s note: This post was originally published on March 17, 2018 and updated on September 2, 2020.

You’ve heard about HSAs and FSAs. And you think they are a good way to save money for and on medical expenses. And your employer offers both as part of its benefits plan.

You’re in luck. You get to choose the option best suited to your needs. And yes, you do have to choose. Because you can’t contribute to an HSA and a Healthcare FSA at the same time. Let’s discover which account type will win in HSA vs FSA.

So how do you choose? To make the best decision for you and your family, consider the details of each account. And compare those to the realities of your family’s medical and financial needs.

To start, let's look at what these accounts have in common.

Health Savings Accounts (HSA) and Healthcare Flexible Spending Accounts (FSA) are pre-tax accounts. And are both used to pay for qualified, out-of-pocket medical expenses. These include, but aren’t limited to, copays, deductibles, coinsurance, and prescriptions. Because contributions are pre-tax, you can save up to 30% on those out-of-pocket expenses. Depending on your tax bracket.

How are HSAs and FSAs different? Account functionality and account holder requirements are different for the two account types. Let’s learn a little more about each account type.

What is a Health Savings Account?

how-to-choose-between-hsa-fsa

A Health Savings Account is a kind of savings account that allows you to save for health care costs. And reduce your taxable income. In other words, HSAs are individually owned, tax-advantaged medical savings accounts. You can open one as an individual or as part of a family plan. As long as you and your family are enrolled in an HSA-eligible High Deductible Health Plan (HDHP).

What’s Considered an HSA-eligible Health Plan?

For 2021, the IRS considers HSA-eligible HDHPs to be health plans with a minimum deductible of $1,400 for individuals. And $2,800 for families. And a maximum out-of-pocket amount of $7,000 for individuals and $14,000 for families.

The IRS adjusts its allowed annual HSA contribution limits annually for inflation. Those limits for 2021 are $3,600 for individuals and $7,200 for families. If you have a mid-year change – like moving from self-only coverage to family coverage, or vice versa, then your annual contribution limit becomes prorated.

How Does an HSA Work?

When you open your HSA, you choose how much you’d like to contribute annually. Then, your employer will deduct the appropriate amount from each paycheck. Your employer may choose to also contribute to your account. But they’re not required to.

If they do contribute, those contributions will count toward your maximum annual limit. Choose your individual contribution amount carefully. And keep in mind that contributions are cumulative. Otherwise, you could end up going over the annual contribution limit.

If you’re under the age of 65, you must use your contributions to pay for qualified medical expenses. These include, but are not limited to:

  • Copays
  • Coinsurance
  • Deductibles
  • Acupuncture
  • Mental health treatment
  • Prescriptions
  • Medical supplies like bandages, crutches, joint braces, and more
  • Hearing aids
  • Dental health
  • Vision tests

Want to see the full list of HSA-eligible expenses? Visit What’s Eligible?

How Age Affects HSA Use & Taxes

age-affects-hsa-taxes

If you’re under the age of 65 and use your contributions for qualified medical expenses, those funds are not subject to federal income tax. But, your state tax liability for contributions depends on your state.

If you choose to use the money for something other than qualified medical expenses, you will incur a 20% tax penalty. And have to pay income taxes on the misused money. After age 65, you can use your health savings on anything you want provided income tax is paid on the amount of the non-qualified disbursement.

What is a Flexible Spending Account (FSA)?

A Healthcare FSA, aka Healthcare Flexible Spending Account, is a spending account your employer makes available to pay for medical expenses with pre-tax dollars.

How Does a Healthcare FSA Work?

If you decide you would like to open an FSA, the good news is that you don’t have to purchase a specific health plan. In fact, you don’t have to purchase any health plan.

But you must elect to participate during your employer’s open enrollment period. Or within 30 days of starting employment if you begin your job mid-year. Then, you select the amount you would like to contribute to your account at that time. Your employer will then deduct the appropriate amount from each paycheck.

Your employer can choose to contribute to your FSA but is not required to do so. And their contributions don’t count toward your annual max. Unfortunately, you can’t change this election at any point outside of open enrollment. Unless you’ve experienced a qualifying life event like the birth of a child, death of a dependent, marriage, or divorce.

qualifying-life-event-fsa-contribution-amount

You also lose any unused money at the end of the year. Unless your employer offers either the option to rollover $500 to next year’s account or a 2.5 month grace period during which you can use leftover funds. So choose your contribution amount carefully.

Like with HSAs, the IRS imposes an annual limit on FSA contributions that adjusts annually for inflation. For 2020, that limit was: $2,750 (2021 limits have not yet been released). Unlike HSAs, FSAs are only opened on an individual basis, so there are no “family plan” increases for annual contribution limits. But if both you and your spouse are offered the opportunity to take part in an FSA at work, you can do so and each can contribute up to the maximum allowed amount.

FSA funds can be used to pay for out-of-pocket medical, vision, and dental expenses not covered by your health insurance plan. Including, but not limited to:

  • Copays
  • Coinsurance
  • Deductibles
  • Acupuncture
  • Mental health treatment
  • Prescriptions
  • Medical supplies like bandages, crutches, joint braces, and more
  • Hearing aids
  • Dental health
  • Vision tests

For a full list of medical expenses that you can use your FSA (or HSA funds) on, check out Publication 502 from the IRS. You can also visit the FSA Store.

Choosing Between an HSA and Healthcare FSA

choose-between-hsa-fsa

Eligibilty Requirements

  • FSA: Only employers can establish an FSA plan for employees to contribute. Employees can open an FSA regardless of if they have a HDHP or not. Self-employed individuals cannot open an account.
  • HSA: Employees are eligible only if they have an HSA-eligible HDHP. Individuals are not dependent upon their employer to offer an HSA. And an HSA can be opened from the private market. Self-employed individuals can open an account.

Contribution Sources & Changes

  • FSA: The contribution amount is chosen during open enrollment or at the time of a qualifying life event. And the contribution amount can not be changed outside of these two time periods.
  • HSA: You can change your contribution amount at any time, no major life event required. This gives you the flexibility to increase or decrease your contribution at any time. Multiple contribution sources: You can grow your HSA in multiple ways. Not only can you add money to your HSA, but your employer, relatives, or anyone who would like to contribute can help your HSA grow.

Rollover Rules

  • FSA: Employers choose whether an employee can keep their unused funds or not. There are three options: Forfeit: Employee forfeits money, and employers get to keep it. Grace period: Employee has a 2.5 month grace period after the plan year ends to use on expenses. Any remaining money after the grace period is employer’s. Carryover: Employees can add up to $500 of unused funds to next year’s plan (in addition to contribution limit). Employers decide the carryover limit, and any funds over the limit are the employer’s.
  • HSA: Funds do not expire from year-to-year. Rollover money is in addition to the contribution limits. Money in your HSA can be carried with you and is available even if you change health insurance plans, get a new job, or retire. And funds left in your account grow tax-free through interest or any investment gains.

Account Ownership

  • FSA: An FSA is owned by the employer. Unused funds belong to employers, not the employee.
  • HSA: Funds stay with you. One of the best perks of an HSA is that the money you save always stays with you because you own the account. If money is left in your HSA at the end of the year, it stays put. No scrambling around trying to find ways to spend the money before the timer runs out.

Access to Money

accessing-hsa-fsa-contributions

  • FSA: Money available from day one. Every penny you contribute to your FSA is available at the beginning of the benefit year. Or shortly after the first contribution is made. Say you add $2,000 to your FSA for the year, you’ll likely contribute about $80 per paycheck. Yet, the entire $2,000 is available to use at any time even though you only make small contributions during the year. Another perk? If you leave a position before the year is over, the money spent from your FSA doesn’t have to be paid back.
  • HSA: As the employee contributes to their plan. An employee only has access to what has actually been deposited into their HSA account.

HSA: A Savings Asset

  • After the age of 65, your HSA functions like any other retirement account. And you can use your HSA money on anything you wish. How does it differ from other retirement accounts? You don’t pay income taxes on money used for medical expenses. You do, however pay income taxes on money used for anything else.
  • HSAs are assets you can pass on to your kin: If your spouse inherits the HSA, it retains its status as a retirement-like account. With the same rules and allowances as it had when you were the account holder. If you pass it on to someone other than your spouse, it stops being an HSA, and inheritance laws apply.

Is an HSA or FSA Better for You?

is-hsa-fsa-better

Deciding between an HSA and FSA depends on your medical and financial needs. The principal requirement for an HSA is enrollment in an HDHP. And while preventative care is covered before the deductible under HDHPs, most other care is not. That means you will have to pay for your medical expenses for you and your family out-of-pocket until you reach your deductible.

An HSA-eligible HDHP makes the most sense in two cases. First, if you or one of your family members has a condition that needs managing by either a specialist or with speciality prescriptions or treatments. In this case, you’ll likely exceed the deductible and be able to use HSA funds to save up 30% on out-of-pocket medical costs.

Secondly, if you rarely use the medical system except for routine preventative care (that includes vaccines and well visits for children) and really want the ability to use your pre-tax account as an investment vehicle to save for retirement. Then, an HSA/HDHP arrangement may be the best choice for you.

To make the best decision for you and your family, start by assessing your past medical needs and those you can project. Then take a look at your finances. Choose the account and health insurance plan arrangement that sits at the nexus of best health coverage and account flexibility.

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.