FSA vs. HSA — What’s the difference and how to choose?

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With open enrollment just around the corner, it’s time to start thinking about what health benefits you’re going to enroll in for the upcoming year.

It can feel a bit stressful as there’s a lot to consider and weighing your options can be overwhelming. To help you make an informed decision, we’re taking a look at the benefits and differences between Flexible Spending Accounts (FSA) and Health Savings Accounts (HSA).

While both of these accounts offer tax advantages, there are a few key differences between the two that you’ll need to know.

FSA vs. HSA

At a high level, FSAs and HSAs are very similar in the sense that they both allow people to set aside money for health care costs. These costs are often referred to as “qualified medical expenses,” which includes deductibles, copayments and coinsurance, and monthly prescription costs.

Here’s a deeper look at the differences between the two.

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 $3,500 for self-only, $7,200 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.
Account owner Employer Employee
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 pre-tax 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 pre-tax as they are considered salary deferrals. Contributions are tax-deductible or can be distributed from your salary pre-tax.
Interest bearing No Yes
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 are 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 towards one of these tax-advantaged accounts.

What’s considered a qualified medical expense?

You can use your FSA and HSA pre-tax / tax-deductible funds towards 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 towards 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.”

Bottom line

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.

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