HSA vs. FSA: What’s the Difference, and Why it Matters

Investing for your health is an integral part of a well-rounded financial plan, especially considering that medical costs will eat up about 15% of your budget in retirement. How can you better prepare? Boost your spendable health dollars by investing in an HSA or FSA.

• What’s the difference between these accounts?

• Can you invest in both at the same time?

• Is one more beneficial than the other?

What’s a Health Savings Account (HSA)?

A Health Savings Account (HSA) is a long-term savings vehicle for medical expenses, and these accounts are rapidly becoming more popular across the U.S. Devenir’s research found that roughly 30 million HSAs covered 63 million people as of last December. People in every state use HSAs, and some states reported that HSAs cover over 77% of people with private insurance. Why are these accounts so valuable? They come with a “triple-tax benefit.” Here’s how it works:

• An employee can contribute funds on a pre-tax basis and receive a tax deduction.

• The funds can be invested (depending on the plan) and grow tax-deferred. The ability to invest contributions makes HSAs an attractive long-term savings vehicle, though few people take advantage of it. The Employee Benefit Research Institute found that only 9% of HSA holders invest a portion of their funds, meaning the other 91% hold everything in cash. The bottom line? Consider investing to help your funds keep pace with inflation and grow over time. 

• When you withdraw funds for “qualified medical expenses,” they are tax-free. Qualified medical expenses can range from insurance premiums to deductibles to out-of-pocket costs. Learn more about what’s considered qualified here. 

Below are some important HSA characteristics:

• Contribution limits (2022): $3,650 for individuals and $7,300 for a family (with a $1,000 catch-up contribution for those 55 or older)

• Key requirements to be eligible for an HSA:

  • Covered by a High-Deductible Health Plan (HDHP)

  • No other health coverage benefits

  • Not enrolled in Medicare

  • Not claimed as a dependent on someone else’s tax return

What’s a Flexible Spending Account (FSA)?

A Flexible Spending Account (FSA) is an arrangement that allows employees to put money into an account to pay for out-of-pocket healthcare costs. A fundamental benefit is that contributions are pre-tax. FSAs typically cover expenses like copayments, deductibles, prescription medications, over-the-counter medications (with a doctor’s prescription), medical equipment, dental expenses, and many other permitted expenses. While FSAs cover various day-to-day medical costs, you can’t use them to pay for insurance premiums. Below are some important FSA characteristics:

• Contribution limits (2022): $2,850 per employee

• Grace period limits: You must use any funds in the account by the end of the plan year. However, some plans (and employers) allow for a grace period that could be up to 2.5 months, allowing you extra time to use the money before it’s gone.

• Rollover/carryover limits: Some employers allow employees to carry over up to $550 per year from an FSA to use in the following year. FSA plans are not required to offer a “grace period” or a “rollover option.” Finally, an employer can provide either the “grace period” or the “rollover option,” but not both. 

In 2021, the IRS provided more (temporary) flexibility with grace periods and carryover limits. For more information, this IRS News Release outlines the changes.

Understanding a Limited Purpose Health FSA

While you usually can’t enroll in both an HSA and an FSA, there is an exception: a Limited Purpose Health FSA. This special FSA only covers eligible dental and vision care expenses. Because of the limited function, it is compatible with an HSA. For those covered by an HDHP and who have an HSA, leveling up their health benefits with a Limited Purpose Health FSA provides an optimized and tax-efficient way to maximize your savings.

Can You Enroll in Both an HSA and an FSA?

Generally, you can’t enroll in both an HSA and an FSA. This is certainly the case if you are covered by a Health FSA. Why? It’s a separate medical plan that reimburses medical expenses. However, you can enroll in both accounts if the FSA is classified as a “Limited Purpose Health FSA” (discussed above). What if you’re married and one spouse is on a healthcare FSA, and the other spouse is contributing to an HSA—is that allowed? Unless it’s a limited-purpose FSA, the answer is no. Healthcare FSAs are considered an additional medical plan, which violates one of the eligibility requirements for HSAs. In this case, you’d have to remove the “excess contributions” from the HSA. 

Which is Better, an HSA or FSA?

The answer depends on your current health needs, future health needs, cash flow, and more. In terms of flexibility and tax benefits, an HSA wins the battle. With an HSA, you don’t have to use all the funds you contribute in a given year. Your contributions roll over every year, giving them more time to compound and grow over the long term. The flexible nature allows people to use an HSA as a larger part of their financial plan, not like a health-specific piggy bank. Both HSAs and FSAs offer pre-tax contributions and tax-free withdrawals for qualified medical costs, but HSAs take the cake with the third tax benefit of tax-deferred growth. Since you can invest the funds in your HSA, you can enjoy tax-free growth long-term. HSAs also offer higher annual contribution limits, allowing you to save more over time. But HSAs aren’t without their faults. A significant drawback is that you must be covered by a high-deductible health plan (HDHP) to contribute, and these plans can get costly. In 2022, the minimum deducible for a plan to be considered HDHP is $1,400 for self-coverage and $2,800 for family coverage. The maximum out-of-pocket costs for HDHPs are $7,050 for self-coverage and $14,100 for family coverage. If you can’t afford those higher payments or expect several doctor or specialist visits, an HDHP may not be the best choice for you. If you can’t get enough of HSAs and FSAs, the IRS Publication 969, Health Savings Accounts, and Other Tax-Favored Health Plans offers rich information that dives even deeper into each of these plans. At the end of the day, the best option for you is the one that fits your financial situation.

Which Account is Right for You? We Can Help.

Deciding which employer benefits to opt-in to can be a challenge. Because of the potential tax benefits and flexibility associated with HSAs and FSAs, it’s critical to make the best decision for your circumstances. Whether you are starting a new job or find yourself on the last day of open enrollment, we’re here to help! We would love to help you optimize your financial plan and ensure you aren’t missing the financial strategies that will put you in the best long-term position. Reach out today.