The most notable difference between an FSA (flexible spending account) and an HSA (health savings account) is that an FSA is owned by the participant’s employer and an HSA is, in practice, controlled by you.
This means that with an HSA, you have more flexibility to roll over contributions to deal with life events. For example, if you leave your job, your FSA contributions may be forfeited, while an HSA typically permits you to keep the contributions you’ve made to the account and transfer them to a new HSA.
What is an FSA?
A flexible spending account is a unique savings account you can contribute to. You can later use it to cover certain designated health care costs that you pay out of pocket. The money you contribute to your FSA is not taxable. When you pay your health care costs through an FSA, you save the equivalent amount of the taxes you would have paid on the contributions to the FSA.
What is an HSA?
A health savings account is similar to a personal savings account. The difference is that the money paid into the HSA is earmarked for the purpose of paying health care expenses. With an HSA, you are its owner, not your employer or any other entity. This gives you more control of the contributed funds compared with an FSA. Like an FSA, a benefit with an HSA is that funds deposited in the account are not taxed.
The table below compares the two options based on 2022 requirements and restrictions.
|Flexible Spending Account (FSA)||Health Savings Account (HSA)|
|Eligibility||Must be offered by your employer||Must have a high-deductible health plan (HDHP)|
|Contribution limit||$2,750 for health FSA, $5,000 for dependent care FSA||$3,650 for self-only, $7,300 for family coverage|
|Contribution changes||Contributions are usually set once elected at the beginning of the year unless a “qualifying event” happens. However, as a result of the COVID-19 pandemic, employees can now change their contributions mid-year if their employer chooses to allow it.||Employee can change the contribution amount anytime throughout the year.|
|Employer contributions||Employers can match employee FSA contributions up to the annual contribution limit, however, the combined contributions cannot exceed the annual IRS limits.||Employers can match employee FSA contributions up to the contribution limit for the year. There are two ways these contributions can benefit the employees. Under the Section 125 plan, a.k.a the cafeteria plan, employees are offered benefits to utilize that can be either pretax or excluded from their gross income. Without the Section 125 plan, all contributions are considered a part of the employee’s income and are tax-deductible.|
|Tax benefits||Contributions are pretax as they are considered salary deferrals.||Contributions are tax-deductible or can be distributed from your salary pretax.|
|Rollover||Use it or lose it — unless your employer allows a rollover, which is typically capped at $500/year. However, as a result of COVID-19 the rollover amount has increased to $550 and has a longer grace period if the employer chooses to allow it.||Unused balances rollover into the next year.|
|Transferability||The account is forfeited after a job change unless you elect COBRA continuation health coverage within 60 days of switching jobs.||Employee keeps account regardless of if he/she changes jobs.|
|Spending allowance||You can spend more than what’s currently in your account so long as your contributions are set-up to reach said amount by the end of the year. To put it more simply, FSAs operate like a line of credit.||You can only spend what you’ve already saved, so HSAs operate more like a debit card.|
It’s also worth noting that you likely won’t be able to have both types of accounts unless your FSA is a “limited purpose” FSA. This is something that you will have to speak with your employer about as eligibility will vary on a case-by-case basis.
If you’re eligible for either an FSA or an HSA, then you should take full advantage of the perks offered by each respective plan. The main benefit of both is that you can save on taxes by opting to put part of your pay toward one of these tax-advantaged accounts.
Should you choose an FSA or HSA?
Remember that flexibility is a key feature of an HSA. In general, you’re able to contribute a greater amount to an HSA each year and still retain the ability to roll over any unused balance at year end. So, if you’re looking for greater flexibility coupled with tax-free benefits and portability for your investment, an HSA may be the best option.
However, there is a trade-off for these HSA advantages. To participate in an HSA, you’ll need to sign up for a high-deductible health care plan, which typically generates larger, and often very high, out-of-pocket health care costs, along with the higher deductible.
While a high-deductible plan may very well be the right choice for younger and healthier people as well as for those with higher and increasing incomes and savings, this may not be best for everyone. For older people on more fixed incomes or for those with health issues that may require frequent trips to the doctor, a more predictable and less expensive (though less flexible as well) FSA might be the right choice.
It will be important to get detailed information about each type plan as it relates to your specific situation. A health care insurance professional may provide the right assistance in helping you understand employer contributions available and compare options for varying deductibles, copays, as well as the specific benefits available for you with an HSA or an FSA.
What’s considered a qualified medical expense?
You can use your FSA and HSA pretax/tax-deductible funds toward thousands of eligible purchases, but before you go spending, be sure to check whether it’s an approved expense.
A good rule of thumb as to whether it’s a qualified expense is if you can consider it a medical need. The IRS tax code refers to the term “medical care” as “amounts paid for diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body.”
Simply put, some of your everyday expenses may qualify as an eligible expense. To double check, browse the FSA store eligibility list.
Here’s a broad look at some popular expenses that typically qualify:
- Medical copayments and coinsurance
- Dental care costs (i.e., dentures)
- Vision care costs (i.e. eye examination, eyeglasses)
- Prescription medications and over-the-counter treatments
Additionally, HSA funds can be used towards post-tax insurance premiums such as COBRA and other long-term care premiums.
Expenses that typically do not qualify as eligible medical expenses include:
- Cosmetics or cosmetic surgery
- Exercise equipment
- Household help
- Funeral expenses
- Fitness programs (i.e., gym memberships)
How much should you contribute?
Once you’ve decided which account to go with, the next step is to decide how much you want to contribute.
One of the key things to consider is the rollover rules for each type of account — FSA funds are on a use it or lose it basis, whereas funds in HSAs can rollover into the next year.
With that being said, if you choose to go the HSA route then it’s recommended that you contribute the maximum amount every year due to its flexibility.
“Unlike the FSA, where you must exhaust your contributions annually, the HSA money can be invested to grow and compound. This is similar to a traditional IRA.” says Barbara A. Friedberg, a financial expert and owner of Robo-Advisor Pros.
If you are able to invest your HSA contributions, then you may be able to grow them tax-free, which will ultimately lead to a larger HSA balance as your contributions will have grown tax-free over time.
When you need the funds, you’re able to easily withdraw them, but if you’re lucky and don’t use them all up by age 65, then you can withdraw the money penalty-free and use it toward anything and only pay income tax — making it a nice bonus to your retirement savings strategy, says Friedberg.
As for FSA contributions, Lauren Anastasio, CFP at SoFi, suggests that you think of it as a strategic spending account.
“While there is a small amount that may be eligible to rollover each year, an FSA should only be funded with the amount you expect to spend during the plan year,” says Anastasio. “If you consistently hit your deductible or have a planned medical expense like surgery or pregnancy, funding your FSA with the amount to cover your deductible would be a great start.”
Flexible spending accounts and health savings accounts are both solid options if you’re eligible. By contributing to these tax-advantaged accounts, you could lower your income taxes while also having funds available for important health expenses.