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HSA vs. FSA – what are the differences? 

Posted: JUL 1, 2019

When you’re evaluating health care options for a new job, the employer may offer some choices beyond the type of health insurance you choose. Choosing a plan that’s compatible with a health savings account (HSA) or a flexible spending account (FSA) is a great way to maximize your benefit plan. And with these accounts, you can reduce your tax liability while you save for expected medical expenses.

An HSA and an FSA are similar because funds from your paycheck or directly from your employer can be deposited into these accounts on a pretax basis. Using a debit card tied to the account, you can spend this money on qualified expenses like prescription medication and prescription eyewear, as well as out-of-pocket costs under your health coverage, like deductibles, copays, and coinsurance.1

Choosing an HSA or FSA can be a great way to take charge of your medical expenses. In this article, we’ll explain and compare the following aspects of health savings accounts and flexible spending accounts:

  • How HSAs and FSAs work
  • Eligibility for HSAs and FSAs
  • Advantages and disadvantages
  • Rolling over HSAs and FSAs
  • Contribution limits
  • Qualified expenses
  • A comparison of HSA features with FSA features

What is a health savings account (HSA)?

An HSA is a financial account that you can fund with pretax contributions from your paycheck or after-tax contributions that are tax-deductible.2 You can use funds in your HSA to pay for qualified medical expenses now or in the future, even if you change jobs or retire. In other words, you own your HSA.

What are eligibility requirements for an HSA?

To be eligible for an HSA, you must have a high deductible health plan (HDHP), which has to be your only health insurance plan (the IRS states specific exceptions for this rule, including coverage for specific diseases or illnesses, accidents, and disabilities).3 You can’t be enrolled in Medicare, and you can’t be able to be claimed as a dependent on anyone’s tax return. For 2019, your health plan must have an out-of-pocket maximum of $6,750 (individual coverage) or $13,500 (family coverage) and a deductible of at least $1,350 (individual) or $2,700 (family). Not all plans with these deductibles are HSA-qualified, though, so be sure to check with your health plan or employer.

You don’t have to get your health plan from an employer in order to have an HSA. If you’re self-employed, you can buy an individual HDHP and contribute to an HSA too.

What are the advantages of an HSA?

  • Many people choose an HSA because of the tax advantages. The money going into the account is taken out of your paycheck on a pretax basis, which reduces your tax liability. In other words, it reduces the amount of taxable income on your paycheck, but you still have that money available in the HSA to spend on qualifying expenses. Subject to IRS limits, you may be able to further reduce your taxes by adding additional funds to the account, on top of any automatic deposit from your paycheck. HSAs are referred to as providing “triple tax savings”:
    1. 1.

      Tax-free contributions

    2. 2.

      Tax-free interest or other earnings on the money in the account

    3. 3.

      Tax-free withdrawals for money spent on qualified medical and dental expenses

  • An HSA is not a “use it or lose it” account. Any funds you don’t spend remain in the account for the future and don’t count against the contribution limits for future years.
  • HSA funds remain with you if you change jobs4 or retire or are no longer enrolled in an HDHP.
  • The ability to keep your HSA funds could allow you to save for a larger deductible plan in the future, which can help you save on premiums.
  • Many HSAs also offer investment options with the potential for investment earnings on the funds in your account.

What are the disadvantages of an HSA?

  • At the time you contribute to an HSA, you must have a high deductible health plan as your only health insurance plan, unless you qualify for one of the exceptions outlined in the IRS guidelines.
  • With an HDHP, all non-preventive care — including prescriptions — is subject to your plan deductible.
  • There’s typically no “spending ahead” based on future contributions you’ll be making, so you have access only to the funds that are currently in your HSA.

What are the annual contribution limits for an HSA?

HSA contribution limits can change yearly. Here are the annual limits for 2019:

  • If you have individual HDHP coverage, you can contribute up to $3,500.
  • If you have family HDHP coverage, you can contribute up to $7,000.
  • If you’re 55 or older, you can contribute up to an additional $1,000.

These limits are higher than those of a flexible spending account (FSA). You can change your contribution amount throughout the year as long as you don’t exceed the annual contribution limit.5

What are qualified expenses?

The funds in an HSA can be spent only on certain expenses. The IRS provides a document with a detailed list, Publication 502, Medical and Dental Expenses,6 but here are some examples:

  • Acupuncture
  • Artificial teeth or limbs
  • Birth control pills
  • Chiropractic services
  • Dental treatment (except cosmetic dental services)
  • Hearing aids
  • Mental health and drug abuse counseling
  • Prescription drugs
  • Over-the-counter medicine for which you’re given a prescription
  • Qualified service animals
  • Removing lead-based paints from surfaces in your home to prevent a child who has or had lead poisoning from eating the paint
  • Travel for medical care

To receive reimbursements (or distributions) for qualified expenses from an HSA, you’ll need to keep records of these expenses and report them using Form 8889 on your federal tax return.7 However, HSA distributions are tax-free when used for qualified expenses. Ask your HSA bank or other financial institution about what type of reporting will be available to you at tax time.

What is a Flexible spending account (FSA)?

An FSA is a financial account that employees can fund with pretax contributions.8 You can use the funds in your FSA to pay for qualified medical or dependent-care expenses. An FSA is owned by your employer, and if you don’t spend the money by the end of the plan year, it remains with your employer, with certain limited exceptions.

What are eligibility requirements for an FSA?

To open an FSA, your employer has to establish it for your workplace. Unlike an HSA, there are no health plan coverage requirements for an FSA, making it possible for employees to enroll in an FSA even if they don’t have health coverage through their employer. If you’re self-employed, you can’t open an FSA.

What are the advantages of an FSA?

  • Your contributions to an FSA are on a pretax basis, limiting your tax liability.
  • Because you set your contribution amount at the beginning of the year (or within 30 days of your mid-year hire date9), you can “spend ahead.” That’s because, unlike an HSA, you have complete access to your total annual election at any time during the year. (This is specific to medical FSAs and doesn’t apply to FSAs used for dependent care expenses).

What are the disadvantages of an FSA?

  • The annual contribution limit is lower than that of an HSA.
  • You must use your contributions in the plan year while you’re at your current job. If you don’t use these funds they’ll remain with your employer, with certain limited exceptions. Because of this, an FSA is sometimes called a “use it or lose it” account.

What happens with my FSA funds at the end of the year?

Your employer decides if you can keep some or all of your unused FSA funds at the end of the year. There are 3 options for the employer to choose from, and the employer makes their selection before the beginning of the plan year.

  1. 1.
    Grace Period: For 2 and a half months after the plan year ends, you can continue using money from the previous plan year on expenses incurred during this 2-and-a-half-month grace period. Any money remaining after this grace period is returned to your employer.
  2. 2.
    Carryover: You can carry over up to $500 of your unused funds (depending on the limit chosen by your employer) to the next year’s plan. This is in addition to the yearly contribution limit for the next year. Any remaining funds beyond the carry-over limit are returned to your employer. (This is specific to medical FSAs and doesn’t apply to FSAs used for dependent care expenses.)
  3. 3.
    Forfeiture: All unspent funds in your FSA are returned to your employer.

What are the annual contribution limits for an FSA?

FSA contribution limits can change yearly. For 2019, you can elect contributions of up to $2,700 to your FSA, which is lower than the maximum HSA contribution. You must choose the amount at the beginning of the year. However, if you have a family status change such as marriage, divorce, or the birth of a child, you can change your election at that time.10

What are qualified expenses?

The funds in an FSA, like with an HSA, can be spent only on certain expenses. These include:

  • Acupuncture
  • Artificial teeth or limbs
  • Birth control pills
  • Chiropractic services
  • Dental treatment (except cosmetic dental services)
  • Hearing aids
  • Mental health and drug abuse counseling
  • Prescription drugs
  • Over-the-counter medicine for which you’re given a prescription
  • Qualified service animals
  • Removing lead-based paints from surfaces in your home to prevent a child who has or had lead poisoning from eating the paint
  • Travel for medical care

The money in your FSA can also be spent on medical expenses for your spouse, children, or any other qualifying dependents you claim on your taxes.11 The same goes for grown children on your insurance plan who will be 27 years of age or younger when the plan year ends, even if you don’t claim them as dependents.

Additional dependent care expenses can be covered by a dependent care FSA (DCFSA). This is another type of FSA, and it can be used to help pay for eligible dependent care services, including child and adult daycare, preschool, or summer day camp.12 For additional details, see IRS Publication 503, Child and Dependent Care Expenses.13

To receive reimbursements (or distributions) for qualified expenses from an FSA, you’ll need to provide a written statement detailing the expense from an independent third party plus an additional written statement stating that the expense isn’t being covered or reimbursed by another plan.14 You don’t need to report FSA distributions to the IRS.

If the end of the plan year approaches and you still have remaining funds left to use, there are online stores that exclusively sell FSA-eligible items.15

What are the differences between HSA and FSA accounts?

This chart provides a simple comparison between HSAs and FSAs, based on some of the key components of these accounts.

Health savings account (HSA) Flexible spending account (FSA)

Annual contribution limits and adjustments

For 2019, employees with self-only HDHP coverage can contribute up to $3,500, and employees with family HDHP coverage can contribute up to $7,000. If you’re age 55 or older, you can contribute up to an additional $1,000. You can change your contribution amount throughout the year as long as you don’t exceed the annual contribution limit.

For 2019, you can contribute up to $2,700. (This is specific to medical FSAs, and the employer has the option of setting a lower limit.) You must choose the amount at the beginning of the year. However, if you have a family status change during the year, you can change your election.

Taxes: Contributions and reimbursements

Contributions are made to your HSA on a tax-free basis (pre-tax or tax-deductible). Distributions (reimbursements) must be reported to the IRS, but they are tax-free.

Contributions are made to your FSA on a pretax basis. Distributions (reimbursements) don’t need to be reported on tax forms and are tax-free.

Unused Funds

Any unspent funds are available for future years and don’t count against annual contribution limits. These funds remain with you if you change employers or retire.

Unless your employer’s FSA includes a 2.5-month grace period or allows a carryover of up to $500 (this applies to medical FSAs only), you lose any unspent funds at the end of the year. You also lose FSA funds if you change jobs.

Fund access

When you have an expense, you have access only to the funds that are currently in your HSA.

You have complete access to your total annual election at any time during the year, regardless of how much you have contributed so far.

Eligibility for the self-employed

Yes. You can open an HSA while 
self-employed or employed by someone else.

No. An FSA is employer-provided only.

Annual contribution limits and adjustments

Health savings account (HSA)

For 2019, employees with self-only HDHP coverage can contribute up to $3,500, and employees with family HDHP coverage can contribute up to $7,000. If you’re age 55 or older, you can contribute up to an additional $1,000. You can change your contribution amount throughout the year as long as you don’t exceed the annual contribution limit.

Flexible spending account (FSA)

For 2019, you can contribute up to $2,700. (This is specific to medical FSAs, and the employer has the option of setting a lower limit.) You must choose the amount at the beginning of the year. However, if you have a family status change during the year, you can change your election.

Taxes: Contributions and reimbursements

Health savings account (HSA)

Contributions are made to your HSA on a tax-free basis (pre-tax or tax-deductible). Distributions (reimbursements) must be reported to the IRS, but they are tax-free.

Flexible spending account (FSA)

Contributions are made to your FSA on a pretax basis. Distributions (reimbursements) don’t need to be reported on tax forms and are tax-free.

Unused Funds

Health savings account (HSA)

Any unspent funds are available for future years and don’t count against annual contribution limits. These funds remain with you if you change employers or retire.

Flexible spending account (FSA)

Unless your employer’s FSA includes a 2.5-month grace period or allows a carryover of up to $500 (this applies to medical FSAs only), you lose any unspent funds at the end of the year. You also lose FSA funds if you change jobs.

Fund access

Health savings account (HSA)

When you have an expense, you have access only to the funds that are currently in your HSA.

Flexible spending account (FSA)

You have complete access to your total annual election at any time during the year, regardless of how much you have contributed so far.

Eligibility for the self-employed

Health savings account (HSA)

Yes. You can open an HSA while 
self-employed or employed by someone else.

Flexible spending account (FSA)

No. An FSA is employer-provided only.

Other ways to save on health care expenses

In addition to saving money for medical expenses with an HSA or FSA, there are also smart ways to reduce those expenses.16

  • Request generic drugs when you’re given a prescription.
  • Ask if your medication is available in bulk (such as a 90-day supply) for a discounted price.
  • Participate in workplace wellness programs; they can improve your health and cut down on the need for medical appointments.
  • Thoroughly review medical bills to avoid paying for mistaken charges.
  • Seek medical care as soon as an issue begins instead of waiting for it to get worse.
  • Go to the proper type of facility for your care. Avoid using the emergency room in nonemergency situations.

Although an HSA or FSA can seem like an extra medical plan that’s necessary only for certain medical budget situations, choosing an HSA or FSA account can be a smart move even if you’ll use it only for the cost-sharing amounts required under your health care coverage, like your deductible or copayment. This especially comes in handy for growing families. When you’re considering how much to contribute to an HSA or FSA account, factor in your individual or family deductible, expected medication costs, doctor visits you anticipate, as well as any long-term plans for surgeries or treatments. It’s always a good idea to anticipate medical costs and have them covered in advance, and an HSA or FSA can help.

 

The tax references in this article relate to federal income tax only. Consult with a qualified professional for tax, investment, or legal advice.

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