A comparison of the two biggest tax-advantaged savings accounts offered by employers
If there was a pop quiz and you were asked to explain the difference between a flexible spending account (FSA) and a health savings account (HSA), would you pass the quiz?
Chances are, you’d probably struggle with the answer. Though they share similar names and some other key similarities, such as both being tax-advantaged options available through work benefits, there are some major differences between the two accounts.
Like any decision, it’s best to make your choice from an informed position. To do so, here are the main takeaways you should know when it comes to the differences between an HSA and an FSA account.
What Is an FSA?
A flexible spending account (FSA) is a tax-advantaged account that is used to reimburse the account holder for qualified medical expenses. Sometimes referred to as a flexible spending arrangement, this account can be funded by both you and your employer. In order to qualify for an FSA, it must be offered by your employer as part of your benefits package.
Similarly to an HSA, there are limits to how much you can contribute – in 2020, contributions are capped at $2,750. However, any money that goes into this account does so tax-free.
Typically, you must spend all of your FSA contributions in the tax year that they were made, but there are some cases where any unused money is allowed to roll over for either a portion of or all of the following year.
How Does an FSA Work?
During your open enrollment period, you are able to sign up for an FSA and determine how much you’d like to contribute. Remember, the funds in your FSA will expire, so don’t put in more than you plan on spending.
In order to have access to the funds then, you must first pay a qualified expense and submit a claim. Upon approval of your claim, the FSA funds will be used to reimburse you.
What is an HSA?
An HSA, or health savings account, is a tax-advantaged account that you can use to pay for medical expenses. Either you or your employer can contribute pre-tax money into the account, which can then be used to cover any qualified medical bills you may procure. Since your contributions will lower your income that’s taxable, this account can help you take your dollars farther.
The main downfall to an HSA account is that it isn’t available to everyone, you must be enrolled in a high-deductible healthcare plan (HDHP) in order to qualify. For this current year, 2020, an HDHP plan is defined as having a minimum annual deductible of $2,800 for a family plan and $1,400 for an individual plan. Additionally, your total yearly out-of-pocket expenses cannot exceed $13,800 for a family plan and $6,900 for an individual one.
Further eligibility constraints include that you are not allowed to be registered on any other health insurance plans, including Medicare, and you cannot be claimed as a dependent on someone else’s tax return.
For individuals who do qualify and open a HAS account, annual contributions are capped at $3,500 for an individual plan or $7,100 for a family. Unlike the FSA account, the money in your HSA doesn’t expire, so you can use it whenever you’d like as long as it’s spent on qualified health-care expenses. This not only allows you more freedom with your time, it gives you the opportunity to allow your account to grow from year to year.
How Does an HSA Work?
So long as you meet all eligibility requirements, individuals with an HSA account can fund it directly from their paychecks with pre-tax dollars, your employer is also allowed to make contributions. Those funds are then available for you to use to cover the costs of any qualified medical expenses such as prescriptions and medications, doctors’ visits, deductibles, and copays, counseling services, dental care, eye care, medical supplies, and more. Should you ever use your HSA account to cover the cost of something that doesn’t fit under the qualified expenses, you would have to pay a penalty as well as income tax on those funds.
One of the ways that you can really make your HSA account work for you is by investing money into it that you allow to grow so that you can use those funds for health-related expenses in retirement. This money ultimately ends up being a triple-threat when it comes to taxes because you contribute the funds tax-free, it grows in the account tax-free, and come time to use it, you’re able to withdrawal it tax-free (so long as you use it appropriately).
Choosing the Right Account
So, now that you know the main takeaways for each account, how do you determine which account is right for your personal needs? For some, you may be able to open both an FSA and an HSA account if they’re available through your employer. Though, typically this only happens if the FSA is a restricted account, meaning you can only use it to cover qualified vision and dental expenses and not more general medical expenses.
More commonly, you are going to have to choose either or. While both have the opportunity to be incredibly beneficial to you, the HSA is likely the better choice between the two. This is due to the fact that both accounts are tax-advantaged, but the funds in an HSA don’t come with an expiration date. This allows you to spend that money as needed, instead of having to worry about planning your expenses out ahead of time. This also allows you more of an opportunity to save up a solid safety-net should you one day need to cover some more expensive healthcare costs – especially if you’re young and have relatively low health costs currently.
Ultimately, there are pros and cons to both accounts and the right choice will depend on your personal situation and healthcare needs. Should you feel that you’d benefit from discussing these accounts in more detail to determine which is best for you, please schedule an appointment with one of our advisors today.
Paces Ferry Wealth Advisors, LLC is a registered investment advisor with the U.S. Securities and Exchange Commission (“SEC”). This material is intended for informational purposes only. It should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney or tax advisor.