Which Health Care Account is Best for You?
Do you have an FSA? An HSA? Is it possible you mix up the two? If so, you’re not alone. Lots of people confuse these accounts.
Both a flexible spending account (FSA) and a health savings account (HSA) are used to help you set aside funds for medical expenses and save money on taxes.
They share a few similarities, but it’s important to understand their key differences if you want to pick the right account for you.
HSA vs FSA: Similarities
An HSA and FSA are both tax-advantaged accounts that let you stash your own money away for future health care costs.
You can open an HSA or FSA at work if your employer offers them. Employers can also make contributions to these accounts.
If you open an account at work, your paycheck funds the HSA or FSA with pre-tax money. That means any money you deposit won’t get taxed for things like Social Security, Medicare or federal income tax.
HSAs and FSAs can be used to pay for qualified medical costs for yourself, your spouse or dependents. Eligible medical expenses can include deductibles, copayments, coinsurance, prescriptions and many over-the-counter medications.
You also won’t pay tax when you spend the money in your account on qualified medical expenses.
FSAs and HSAs are each subject to an annual contribution limit. Finally, both accounts let people aged 55 and older make an additional catch-up contribution of $1,000 per year.
HSA vs. FSA: Key Differences
HSAs and FSAs may sound similar — but they really don’t have much in common. Their differences outweigh their similarities.
Flexible Spending Account Features
You can only establish an FSA with your employer. This means your employer — not you — owns your FSA account. If you leave your job, you lose your FSA funds.
In 2022, the contribution limit for a health care FSA is $2,850.
Use It Or Lose It
The biggest drawback to an FSA is that the money in the account is “use it or lose it,” meaning you lose whatever money you don’t use up by the end of the year.
If FSA money is left in your account at the end of December, your employer can offer one of two options:
- A 2.5-month grace period to spend the leftover money.
- A carry-over of up to $500 to spend the next plan year.
Or your job can choose to terminate any remaining funds when a new year starts. It’s up to the employer.
Finally, you can only adjust FSA contribution amounts at open enrollment or with a change in employment or family status.
Funds Are Available Immediately
A big advantage of an FSA is that all your funds are available immediately the day you enroll. Even though you haven’t paid in yet, the full contribution amount you elected during open enrollment is accessible to spend on health expenses at the beginning of the year.
You can also use an FSA with any health insurance plan.
You can’t deduct FSA contributions on your tax return. However, funds are withdrawn from your paycheck before taxes are deducted, so any money you contribute to an FSA is not subject to payroll taxes.
You can’t use your FSA to pay for health insurance premiums.
Dependent Care FSA
A dependent care FSA is a separate account you can sign up for at work, if your employer offers it.
These accounts are used to pay for eligible dependent care services, including preschool, summer day camp, after-school programs, and child or adult daycare.
In 2022, you can contribute up to $5,000 per year to a dependent care FSA if you are married and file a joint tax return with a spouse, or if you file as single or head of household.
Health Savings Account Features
Here’s where the primary differences between FSAs and HSAs come in.
Unlike an FSA, you must meet the following requirements to contribute to a health savings account:
- You are not claimed as a dependent on anyone else’s tax return.
- You are not enrolled in Medicare.
- You are covered under a high-deductible health plan (HDHP).
Must Be Enrolled in a High-Deductible Health Plan
An HSA is intended to help people offset the cost of high-deductible health plans (HDHPs). You must be enrolled in one of these plans to contribute to an HSA.
In 2022, the minimum deductible for an HDHP is at least $1,400 for self-only coverage and $2,800 for family coverage. The minimum deductible for these plans increases slightly each year.
HSAs can pay for qualified medical expenses, like doctor’s visits, over-the-counter medication, prescription medications, dental expenses and more.
You can create an HSA on your own or at work with your employer.
If your employer sets up an HSA, your account and the money inside goes with you if you leave your job or retire.
Even if you switch to a different health plan down the road, you can still spend down any remaining HSA funds in your account.
Plus, unused funds roll over year after year. They’re not “use it or lose it.”
If you have an employer-sponsored HSA, you’ll fund it with pre-tax dollars from your paycheck. If you set up your own HSA independently, your contributions are tax deductible on your federal tax return.
This can be a great perk, since tax deductible contributions help lower your taxable income, saving you money when tax time rolls around.
You can also invest the money in your HSA instead of spending it on current medical costs, and it grows tax-free over time. Many health savings accounts let you invest your money in stocks, bonds, mutual funds and ETFs. Plus, you’ll enjoy tax-free earnings and interest inside your HSA investment account.
Penalties and Annual Contribution Limits
Health savings accounts come with yearly contribution limits. The maximum yearly HSA contribution in 2022 is $3,650 for an individual medical plan and $7,300 for someone with a family plan.
You can use the money any time for medical expenses, and you’ll never pay taxes on it. If you withdraw money for non-medical expenses before age 65, you’ll owe the IRS a 20% penalty, plus income taxes.
After age 65, you can withdraw money from an HSA penalty-free for any reason, although you’ll still pay income tax on the distribution. In that way, it works a lot like a 401(k) for living on in retirement.
FSA vs. HSA: Key Differences
|Feature||Flexible Spending Account||Health Savings Account||.|
|Eligibility requirements||Set up by an employer||Must be enrolled in HDHP|
|Annual contribution limits||$2,850 in 2022||$3,650 indiv, $7,300 fam|
|When can you change the contribution amount?||Only at open enrollment||Anytime|
|Rollover rules||Use it or lose it||Unused funds roll over|
|Tax treatment||Tax free||Tax free|
Is an HSA or FSA Right For You?
If you’re looking for flexibility — and are covered by a high-deductible health plan — an HSA is a solid choice.
You can contribute more money per year to this account, and unused HSA funds stay with you year after year, even if you retire or make a job change.
FSA accounts offer less flexibility than HSAs, but they can still help you save money for medical costs. They also come with tax benefits. Finally, you can use an FSA with any health insurance plan and the funds are available immediately at the beginning of the year.
Not all jobs offer flexible spending accounts. If that’s your situation, an HSA might be your only option.
However, it’s important to consider the high out-of-pocket costs associated with an HSA-eligible health plan. If you have high medical bills, you’re better off with a different type of health insurance, like a PPO or HMO.
Here are some questions to consider if you’re trying to decide between an FSA and HSA:
- Does my employer offer an FSA or HSA account?
- How much do I plan to spend on health care expenses this year?
- Does my family typically have high medical costs?
- Do I want the account to be portable so I can access the money when I change jobs?
- Can I qualify for an HSA with my current health insurance?
- Do I want to invest my funds so my money can grow tax-free earnings?
Can You Have Both an FSA and HSA?
You can’t contribute to an HSA and a traditional health FSA in the same year.
However, HSA holders can contribute to a limited purpose FSA for dental and vision expenses, or to a dependent care FSA for child care costs.
This can be a smart move if you have children and want a tax advantaged way to pay for child care. You can calculate at the beginning of the year how much you plan to spend on things like daycare and summer camp, then allocate that amount to an FSA.
This way, you contribute to your HSA for medical expenses and keep an FSA for dependent care expenses.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.