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

Investing in your health is an integral part of a well-rounded financial plan, especially considering that healthcare costs can take up a significant portion of your budget in retirement. One way to prepare is by boosting your spendable health dollars with a Health Savings Account (HSA) or a Flexible Spending Account (FSA).

1. What’s a Health Savings Account (HSA)?

A Health Savings Account (HSA) is a long-term savings vehicle for medical expenses that offers a “triple-tax benefit”:

1. Contributions are made on a pre-tax basis and may be tax-deductible.

2. Funds can grow tax-deferred, and you can invest the contributions to keep pace with inflation.

3. Withdrawals for qualified medical expenses are tax-free.

Qualified medical expenses can include insurance premiums, deductibles, and out-of-pocket costs. HSAs offer flexibility and long-term growth potential, making them an effective tool for retirement healthcare planning.

Below are some important HSA characteristics:

• Contribution limits are set by the IRS and typically updated annually.

• Must be paired with a High-Deductible Health Plan (HDHP).

• Other eligibility rules apply, such as not being enrolled in Medicare.

What’s a Flexible Spending Account (FSA)?

An FSA allows employees to set aside pre-tax dollars to pay for out-of-pocket healthcare costs, including copayments, deductibles, prescription medications, and medical equipment. FSAs generally cannot be used for insurance premiums.

Below are some important FSA characteristics:

• Annual contribution limits are set by the IRS.

• Some plans allow funds to carry over a limited amount to the next year or offer a short grace period to use remaining funds.

• Plan rules vary by employer.

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 their 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 best choice depends on your current and future healthcare needs, cash flow, and overall financial goals:

• HSAs offer rollover of funds year-to-year and the ability to invest contributions for long-term growth.

• FSAs provide immediate access to pre-tax funds for current-year healthcare expenses.

• HSAs generally allow higher contribution limits and provide a third tax benefit through tax-deferred growth.

When choosing between the two, consider your health coverage, expected medical costs, and risk tolerance. Always confirm contribution limits and plan rules for the current year, as the IRS updates these annually.

Which Account is Right for You? We Can Help.

Deciding which benefits to utilize can be challenging. With the potential tax benefits and flexibility offered by HSAs and FSAs, it’s critical to make the best decision for your circumstances. Whether starting a new job, switching plans, or reviewing your long-term healthcare strategy, you can optimize your financial plan and ensure you’re positioned for the best long-term outcomes. Reach out today.