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The difference between an HSA and an FSA

Healthcare can be expensive. Learn how FSAs and HSAs can help you save for qualified medical expenses.

If you've wondered, "What is an HSA or FSA?" you're not alone. Navigating the world of healthcare savings plans can be tricky. Health savings accounts (HSAs) and flexible spending accounts (FSAs) offer ways to save money on qualified medical expenses using pre-tax dollars. However, deciding which is right between an HSA vs. an FSA means understanding a few key differences.

Exploring the benefits and distinctions between each can help you make a more informed decision about which can help you best manage your healthcare spending. Here's what you need to know.

What is a health savings account (HSA)?

An HSA is essentially a special savings account for qualified medical expenses. To be eligible for an HSA, you must be enrolled in a high-deductible health plan (HDHP). These plans generally have lower premiums, but you may have to pay higher deductibles before your insurance coverage kicks in.

In 2024, an HDHP is a plan with an annual deductible of $1,600 for individuals and $3,200 for families, with annual out-of-pocket expenses not exceeding $8,050 for single coverage and $16,100 for families.

Remember that the Internal Revenue Service (IRS) sets annual contribution limits for HSAs. In 2024, the maximum contribution is $4,150 for an individual and $8,300 for a family. If you're over 55, you can add a catch-up contribution of $1,000.

Health savings accounts are powerful because they offer a triple tax advantage:

Tax-deductible contributions — Any money you contribute comes from your paycheck pre-tax, lowering your taxable income.

Tax-free growth — Any interest or investment earnings grow tax-free within the account.

Tax-free withdrawals — The funds you withdraw for qualified medical expenses aren't taxed.

So, what qualifies under HSA expenses? Typically, HSAs cover a wide range of medical costs, including:

  • Doctor's visits
  • Prescriptions
  • Some over-the-counter medications
  • Some medical equipment.

The IRS has a detailed list of eligible medical expenses on its website.

Pros of HSAs

HSAs offer significant financial benefits for those who can manage them effectively. Here's a look at some of the key advantages.

Triple tax advantage — Contributions are tax-deductible, earnings grow tax-free within the account, and you can make tax-free withdrawals for qualified medical purchases.

Roll over annually — Any unused funds roll over from year to year, allowing you to accumulate significant savings over time—even for future expenses in retirement.

Potential for investment growth — Many HSAs offer investment options, letting your money potentially grow faster than it would in a typical savings account.

You own the account — Even if you change jobs or health insurance plans, your HSA stays with you.

Cons of HSAs

While HSAs offer many advantages, it's also important to consider the potential drawbacks before opening an account.

High-deductible requirement — To contribute to an HSA, you must be enrolled in an HDHP, which means you'll likely pay more out of pocket before your insurance coverage kicks in.

Pressure to save — Because you're responsible for upfront medical costs, it's crucial to diligently contribute to your HSA to avoid potential financial strain.

Taxes and penalties — If you withdraw funds for non-qualified expenses, you'll owe income tax and potentially a 20% penalty (unless you're over 65).

Keeping records — You must keep receipts and documentation to verify any HSA funds are spent on qualified medical expenses.

What is a flexible spending account (FSA)?

An FSA is an employer-sponsored account that allows you to set aside pre-tax dollars to pay for qualified healthcare and dependent care expenses. Self-employed people are not eligible. Unlike HSAs, you don't need to be enrolled in any specific type of health insurance plan to be eligible. However, FSAs are only available if your employer offers them as a benefit.

As with HSAs, flexible spending accounts also have contribution limits set by the IRS. In 2024, any employee who participates in an FSA can contribute up to $3,200 through payroll deductions. Some plays may also allow employer contributions. Couples with plans through their employers can contribute up to $6,400 for their household.

Some FSAs allow the funds to carry over each year. In 2024, the maximum carryover to 2025 is $640. For any unused amounts in 2023, up to $610 can be used in 2024.

Pros of FSAs

While FSAs have limitations compared to HSAs, they still offer some valuable tax benefits for managing healthcare expenses, including:

Tax savings — Your contributions aren't included in your current year's gross income, which helps reduce your taxable income and saves money on your taxes during the years you contribute.

Qualified expenses paid with tax-free dollars — You can use FSA funds to pay for eligible medical or dependent care expenses tax-free, providing additional savings.

Employers can contribute — While it's not as common, some employers choose to contribute to FSAs as an additional benefit, and the contributions don't count toward the annual maximum.

Cons of FSAs

It's also important to understand the potential downsides of FSAs to help you make an informed decision about this type of account. Some disadvantages include:

Use it or lose it — FSAs generally have a use it or lose it rule, meaning you must use most of your funds by the plan year's end, or you may have to forfeit the remaining balance.

Lower contribution limits — FSAs have lower annual contribution limits than HSAs, so you may be unable to take advantage of the tax-free withdrawal benefits each year.

Employer-provided — FSAs are only available if your employer offers them, and your employer may set specific rules for how and when you can use the funds.

HSA vs. FSA: key differences

Understanding the distinctions between HSAs and FSAs is crucial for making the right financial choice regarding healthcare expenses. Here are some key differences:

Ownership and portability — HSAs belong to you; you can take them with you if you change jobs or health insurance plans. FSAs are tied to your employer, and you generally lose access to the funds if you leave your job.

Flexibility and rollover   HSAs offer greater flexibility. Unused funds roll over from year to year, allowing you to build up savings over time. With FSAs, you must spend most of your funds within the plan year or risk forfeiting them.

Investment potential — Many HSA providers offer investment options, allowing your healthcare savings to grow. FSAs do not offer investment options.

Eligibility  You must be enrolled in an HDHP to be eligible for an HSA. Your employer can only offer FSAs.

What is the difference between an HSA and an FSA?

The primary differences are around ownership, flexibility, and how unused funds are handled. HSAs are owned by you, offering long-term savings potential and portability if you change jobs. FSAs are employer-tied with a use-it-or-lose-it requirement for most funds.

Can you have both an HSA and an FSA?

Generally, you can't contribute to both an HSA and a Health FSA in the same year. The IRS considers a health FSA other health coverage, which disqualifies you from HSA eligibility.

In rare cases, you may have both an HSA and an FSA, but it's uncommon. For example, if you have a Limited Purpose FSA (LPFSA), which is specifically for dental and vision expenses, you can still contribute to an HSA. This allows you to maximize your tax savings across various qualified medical expenses.

Build a healthcare savings plan

Navigating the world of healthcare savings plans can be tricky. HSAs and FSAs both offer ways to save money on qualified medical expenses using pre-tax dollars. Understanding the key differences between the two options can help you make better decisions about managing your healthcare spending.

Learn more about HSAs and FSAs and how they can help you pay for qualified medical expenses.

Key Takeaways

HSAs offer long-term savings potential.

FSAs are offered by your employer.

You generally can't have both an HSA and an FSA.

 

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