HSA or FSA: Which Flexible Spending Arrangement Should You Choose?
How to Choose the Tax-Advantaged Account That's Right for You
There’s been a lot of buzz in recent years about Health Savings Accounts and Flexible Spending Accounts – HSAs and FSAs respectively. Both are tax-advantaged accounts that let you save for medical costs, and many companies offer them as options in employee benefits packages. There are good reasons to take advantage of both HSAs and FSAs, but there are key details that differentiate them. Since you typically cannot have both, it’s important to determine which is the better option for you.
Understanding HSAs and FSAs
Both of these types of accounts are for people with health insurance who want to set money aside specifically for health care costs. Essentially, they are personal savings accounts, but these funds can only be used for “qualified medical expenses.” These include copayments, deductibles, coinsurance, and monthly prescription costs. Although the particulars of accounts may differ, you will usually receive a debit card for your account, and that’s how you access the money to make qualified payments. Both HSAs and FSAs also offer tax advantages, though there are key differences.
More About Health Savings Accounts (HSAs)
Although we mentioned above that HSAs function like a personal savings account, they are not quite the same thing. HSAs, for instance, is only available to people who have a high-deductible health plan (HDHP). The federal government makes a determination annually about the minimum deductible amount a plan can have in order to qualify as an HDHP. They also set the maximum amount plan holders can contribute each year. (Check out the most recent contribution limits here.)
Many people take advantage of an HSA offered through their employer, but you can also open an HSA with a private insurance plan. However, you cannot make current-year contributions unless that insurance plan is an HDHP.
If your HSA is through your employer, your contributions will usually be pre-tax, straight from your paycheck. If your HSA is not through your employer, your contributions would be after-tax, but they are tax-deductible. HSA funds can also be invested if your plan custodian permits it, meaning any money you don’t spend on qualified medical expenses can remain in your account and grow tax-free.
Not everyone will qualify for an HSA, even with a high-deductible health plan. This is because the HDHP must be your only health insurance. If you qualify for Medicare or you can be claimed by someone as a dependent for tax purposes, you do not qualify for an HSA. Also, it should be noted that not all HDHPs are HSA-eligible, so make sure you choose one that is.
When you need to use the money in your HSA to pay for qualified medical expenses, you won’t pay taxes on those funds. If you use the money for non-qualified expenses, however, you’ll pay a penalty tax. After you enroll in Medicare, you won’t be able to contribute to your HSA any longer, but you can withdraw from it for other expenses without paying the penalty.
More on Flexible Spending Accounts (FSAs)
One important way in which FSAs differ from HSAs is that you cannot get an FSA on your own – it must come from your employer as part of your benefits package. Like an HSA, though, you can use the funds for the same qualified medical expenses.
FSAs also typically come with a “use it or lose it” clause, meaning any money remaining unspent in your account at the end of the calendar year will be lost to you. The exception to this is if your employer offers a rollover option, but a rollover is still limited by the IRS to just $500.
Your FSA contributions will come out of your paycheck before taxes and in regular increments. However, these accounts are considered “pre-funded” meaning, although you haven’t paid in full for the year, the full contribution amount you selected with your plan at the beginning of the year will be available to you right away. While this can certainly be a useful benefit, you also must be wary. If you end up leaving your company mid-year, you will have to pay back any funds you spent that weren’t yet covered by your regular paycheck deductions.
Choosing Between an HSA and FSA
You can see that both HSAs and FSAs can be beneficial savings vehicles for managing your medical costs, but you’ll usually have to choose between them because you cannot have both at once. The exception to this rule is if you qualify for an HSA and your FSA is a “limited purpose” FSA, which you can learn through your employer’s human resources representative. These accounts can only be used for dental and vision care expenses.
So, most people are left with a choice to make. Generally, if you are on the younger and healthier side, with no medical conditions and no maintenance prescriptions, an HDHP with an HSA may be a good fit for you. HDHPs are some of the most cost-effective plans available if you don’t expect many medical costs. If you do, an HDHP may not work for you because the trade-off to cheap premiums is very high out-of-pocket costs – upwards of $16,000 annually for a family. That amount is far greater than what you can usually contribute to an HSA throughout the year, meaning if you contribute the maximum to your HSA but you still have high medical costs, you’re going to end up paying out-of-pocket anyway.
Health plans that are not considered HDHP cost more per month, of course, but they usually also cover more of your medical costs for you. For this reason, people with high medical costs are usually better off selecting a generous (though more expensive) health plan than an HDHP, which disqualifies the HSA as an option.
FSAs offer less flexibility than HSAs, to be sure, but they are still useful in helping you save money for medical expenses. Since they can be paired with any type of health plan your employer offers, an FSA can be a great tool for you if your chosen plan disqualifies you from using an HSA.
Final Thoughts on HSA and FSA Selection
For most people, electing to use an HSA or FSA is a savvy financial move. We all have some health expenses throughout the year, even if we are relatively healthy, and remember that these plans can cover things like copays, deductibles, and prescriptions. Planning ahead to pay for them with tax-advantaged accounts makes good financial sense.
If you’re making the decision between an HSA and FSA for yourself or your family, make sure you learn as much as you can about your options. This will ensure you can get the most out of your chosen plan and that you can cover as many of your expected medical costs as possible using a tax-advantaged strategy.