- Both FSA and HSA accounts offer tax-advantaged ways to save money and cover your health-related expenses.
- The key differences between the two accounts are who qualifies for which type and the ability to roll over your account balance after the year ends (or when you leave your employer).
- Health care savings should be an important part of your budget in order to keep your family protected and maximize the tax benefits offered by the IRS.
It’s time for open enrollment and your human resources department asks whether you’d like to open a health savings account (HSA) or a flexible spending account (FSA). You know these are both designed to help you pay for medical expenses, but you aren’t quite sure what the differences are between the two. You’re riddled with questions: “Do I qualify for both? Can I roll over my money if I don’t use it? Are they both funded using pre-tax dollars?”
Both FSA and HSA accounts are worth considering, as they offer a tax-free way to save for medical expenses like medication, childbirth, physical therapy, general medical exams, and more. You’re able to save a significant amount each year — whether it’s for preventative care or for temporary or chronic health conditions. Because you don’t pay income taxes on this money, you can direct what you would have otherwise paid in taxes into one of these health plans instead.
If you’re attempting to decide whether an FSA vs HSA is right for you, you’ve come to the right place. This guide will help you determine which type of account is ideal for your specific needs.
What is an FSA?
An FSA, or flexible spending account, is an account that is typically established by one’s employer and funded by an employee’s pre-tax income. On occasion, some employers will contribute to an employee’s FSA account. You set your contribution amount upfront, which will be evenly deducted from your paychecks each pay period.
One important thing to remember about an FSA (which is often also referred to as a flexible spending arrangement) is that if you don’t use the money you’ve set aside during the plan year or you leave your job, you lose that money.
Despite the use-it-or-lose-it stipulation, there are two exceptions: An employer can provide a grace period of 2.5 months after the plan year has ended for employees to use the money, or they can allow employees to carry over $500 to use in the following year. However, not all employers offer these exceptions.
Keep in mind that if something urgent occurs, you can use your total annual contribution immediately, even if you haven’t put any money into the account yet. And if you leave your employer, you won’t be forced to pay this money back.
Other things to keep in mind about FSAs:
- For 2019, the maximum contribution amount allowable by the IRS is $2,700. An employer can opt to offer less.
- FSA funds can be spent on a range of medical expenses. These include general medical expenses (including dental and vision), hospital services, childbirth, chiropractor services, prescription medication, breast pumps, artificial limbs, long-term care premiums, COBRA premiums, X-rays, psychiatric care, vasectomies, substance abuse treatment, artificial teeth, physical therapy, mastectomies, forms of birth control (including condoms and implants), fertility enhancement, and antacids.
- Funds cannot be spent on health insurance premiums.
- You do not have to report FSAs on your income tax return.
- Self-employed workers are not eligible for FSAs.
What is an HSA?
While an FSA is sponsored by an employer, an HSA, or health savings account, can either by set up through an employer or by an individual. There is one major limitation though: HSAs are only available for people who are on a high-deductible health plan (HDHP). Plus, people on Medicare are not eligible for an HSA. On top of that, not all insurance plans offer an HSA. If your insurance plan doesn’t, you can always open an HSA through a different insurance provider.
Here’s another FSA vs HSA difference. While FSA funds expire at the end of the plan year, HSA contributions can be rolled over. If you leave your job with the employer you started the HSA plan with, you can still carry your funds over, as they’re yours.
There are contribution limits for HSAs, which are $3,500 per person or $7,000 per family for 2019. (In 2020, these contribution limits will be increasing to $3,550 and $7,100.) To assist older individuals, there is an exception that allows those over age 55 to contribute an additional $1,000 per year. These are annual contribution limits, and the amounts are prorated based on the portion of the year that you are eligible for an HSA: i.e., you can only contribute the full amount if you were enrolled in an HDHP for the full year.
HSAs have great tax benefits — not only can you reduce your taxable income, and therefore reduce your income taxes during the year of contribution, but you can also grow your money tax-free. That money can be invested, meaning an HSA can be an important part of your retirement savings strategy.
Other things to keep in mind about HSAs:
- HSA eligible expenses are the same as they are for FSAs, as outlined above.
- Funds cannot be spent on health insurance premiums.
- If your medical expenses aren’t qualified, you could face Internal Revenue Service (IRS) penalties, which are 20% of each withdrawal. You will also be forced to pay taxes on the withdrawal.
- If you withdraw funds for non-medical use after age 65, you won’t face the fine, though you will still have to pay taxes on the withdrawal.
- Funds withdrawn for qualified expenses are tax-free.
- HSAs must be reported on Form 1040 or Form 1040NR come tax season.
- Self-employed people can open an HSA.
- HSA funds can be passed to a beneficiary, like a spouse, in the event of death. Any other beneficiary aside from a spouse will have to pay taxes on the money.
How To Choose the Right Plan For You: FSA vs HSA
After reading the above, you might still be wondering which plan is ideal for you. Use the below guidelines to ensure you make the right call.
Choose an FSA if…
- An HDHP is not the right plan for you and your family.
- You’re comfortable with the $2,700 contribution limit.
- You’ll likely use the funds within the plan year and can foresee medical and dental expenses early in the year.
- You’re OK with regular deductions from your paychecks, as deductions are pre-set when you enroll.
Choose an HSA if…
- You decided to go with an HDHP, such as those offered under the Affordable Care Act.
- You’re self-employed.
- You want higher contribution limits than an FSA offers.
- You like having the ability to roll over your funds at the end of the year.
- You want to grow your savings balance over time as part of your retirement planning strategy.
- You want the ability to change your contributions as you see fit.
Keep in mind that although the tax reporting requirements differ, record-keeping is important for both accounts in the event that you’re audited by the IRS. Keep receipts and bills related to FSA or HSA spending for three years. For more tax rules and details on FSAs and HSAs, see the IRS guide on these tax-favored health plans.
An Integral Part of Your Budget
Health care savings should be an important part of the “needs” category in any family’s budget. An FSA or HSA can be a great way to plan ahead when it comes to health expenses. They allow you to keep your family protected while also saving you money. When choosing between an FSA vs HSA, remember that although both account types have some similarities, they differ in unique ways. Before you commit to one account type, make sure you’ve carefully looked at the pros and cons of each and whether you qualify.
Remember: Nothing is set in stone. If you opt for an FSA or HSA and discover it’s not right for you or your situation has changed, you can opt out the following year. When it comes to HSAs, you can even change your HSA contributions within the plan year.
If you have other financial priorities right now, like paying off debt or saving for retirement, you can always keep your FSA or HSA contributions small for now — taking advantage of the tax savings offered — and increase them in the future. What matters most is to get started with a plan that fits with both your current and long-term financial goals.