Health Savings vs. Flexible Spending Account: An Overview
Healthcare can be costly even for the heartiest among us. Even if you have insurance through your employer, you might consider taking advantage of one of the federal government programs that encourage saving for medical expenses not covered by insurance. The tax benefits can be substantial.
The two types of accounts most often offered to employees are the Health Savings Account (HSA) and the Flexible Spending Account (FSA). Self-employed people can open an HSA but not an FSA. To be FSA or HSA eligible you have to meet specific guidelines.
- Health savings accounts (HSAa) and flexible spending accounts (FSAs) are two fringe benefits offered by some employers that allocate pre-tax dollars for special purposes.
- HSAs and FSAs, while structurally similar, are intended for different purposes and must be used accordingly.
- Contributions to HSAs are made with pre-tax dollars and are associated with high-deductible health insurance plans to help defray some of the costs of the high deductible, and can be rolled over each year.
- Contributions to FSAs are also made on a pre-tax basis and cover a wider variety of activities, such as child care if you designate the account as a Dependent Care FSA, but you must use-it-or-lose-it.
Health Savings Account
An HSA is offered by employers in conjunction with a high deductible health insurance policy. Self-employed people who have high deductible plans also can set up HSA accounts.
The employer or self-employed individual deposits all or a portion of the deductible into an HSA to cover costs until the deductible is met and the health insurance policy takes over the financial burden.
Once the account is set up, an employee can contribute additional money to the HSA via a payroll deduction from gross income. The money contributed to an HSA account is made with pre-tax dollars and thus reduces the amount of income reported for tax purposes. Interest or earnings on the money in the account is also tax-free.
HSA withdrawals used to pay for qualified medical expenses are tax-free transactions.
Withdrawals from Health Savings Accounts
A withdrawal from an HSA can be used for a broad range of medical expenses including eyeglasses, contacts, chiropractic care, and prescription drugs as well as doctor visits and hospital stays.
The HSA is a portable account so you keep your money even if you switch jobs. In order to qualify for an HSA, you have to be enrolled in a high-deductible health plan. In most cases, you are not eligible if you have other health coverage or can be claimed as a dependent by someone else.
Flexible Spending Account
An FSA is similar to an HSA, but there are a few key differences. For one, self-employed individuals aren't eligible.
One of the biggest benefits of an FSA is that it can be set up as a Dependent Care FSA (DCFSA) to allow withdrawals for childcare expenses. It is also possible to have a separate, regular FSA to cover medical expenses depending on your company's plan.
Like the HSA, you can contribute to an FSA using your gross pay, making the contributions tax free. As long as you use the funds to pay for qualified medical expenses, you probably won't owe taxes on withdrawals.
Use FSA Funds or Lose Them
Unlike an HSA, you have to declare how much you would like your employer to deduct from your gross pay in order to fund your FSA in each calendar year. Once that declaration is made, you generally can't change it.
If you declined the FSA during the open enrollment period, you probably have to wait until the next open enrollment.
Your declared funds must be spent within the tax year, although a grace period is sometimes granted until the tax filing deadline. The money you contribute can be lost if you don't spend it by all by the deadline.
You don't have to be covered under a health insurance policy to be eligible, but FSA funds are not an adequate substitute for health insurance. If you can't afford both, it would be better to put those funds toward health insurance.
HSA vs. FSA
The table below shows the differences and similarities between both health accounts:
Must have a qualified high deductible health plan (HDHP).
Self-employed can contribute.
All employees are eligible regardless of whether they have insurance or not.
Self-employed cannot contribute.
|2021 Contribution Limit||
$3,550 Individual Coverage
$7,100 Family Coverage
|Contribution Source||Employer and/or employee||Employer and/or employee|
|Rollover||Unused contribution can be rolled over to the next year.||Unused contribution is lost at end of year.|
|Withdrawals||Allowed, but includes tax withheld plus 10% penalty.||Not allowed.|
|Interest Earned||Interest earned in the account is tax-free.||Account does not earn interest.|
Employee keeps account even if s/he changes jobs.
|Account is forfeited after a job change.|
|Accessibility||Can only access what has been contributed into the account.||Complete access to the annual election amount, regardless of whether the account has been fully funded or not.|
|Contribution Amendment||Employee can change contribution amount during the year.||Employee is stuck with the contribution amount chosen at the beginning of the year.|
The Bottom Line
If you meet the eligibility requirements, an HSA is typically a better choice for most, because you can contribute a higher amount and unused funds roll over to the following year. If you are enrolled in a high-deductible health plan that meets the rules of eligibility established by the IRS, you are free to enroll in an HSA either through your employer or on your own.
Still, many companies offer both HSA and FSA plans, and under certain conditions, you may be able to sign up for both. In either case, establishing a medical savings plan can represent significant annual tax savings depending on your tax bracket. If you establish an FSA, just keep an eye on the account to make sure you don't let any accrued money expire at the end of the year.
The eligibility requirements, allowable contributions, and rules for medical savings plans are established by the IRS. You can reference these details in IRS publication 969.