Difference Between FSA and HSA: Tax Advantaged Healthcare

It can be difficult to understand the difference between FSA and HSA accounts. Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) both offer tax advantages and can help individuals save money on medical costs, but they operate under different rules and provide varying levels of flexibility. 

Whether you're a new employee reviewing benefits options or someone looking to optimize their healthcare spending, understanding these two account types can significantly impact your financial planning and healthcare decisions. This blog will define these two options, cover their differences and discuss use case scenarios, so you can more easily pick the account that is most suitable for your needs.

Table of Contents

• What is an HSA?
• What are the Benefits of an HSA?
• HSA Use Case Example
• What is an FSA?
• Benefits of an FSA
• Difference between FSA and HSA
• Can I have both an FSA and HSA?
• Which Tax-Advantaged Healthcare Option is Right for Me?

What is an HSA?

Health Savings Account (HSA):  tax-advantaged medical savings accounts exclusively available to individuals enrolled in a High-Deductible Health Plan (HDHP). The account offers a triple tax advantage: tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. 

In 2024, individuals can contribute up to $4,150, while families can contribute up to $8,300, with an additional $1,000 catch-up contribution allowed for those 55 and older. One of the most attractive features of an HSA is that funds roll over year to year and stay with you even if you change jobs, making it a powerful tool for both current healthcare expenses and long-term savings. 

After age 65, the funds can be used for non-medical expenses (subject to regular income tax), effectively turning it into an additional retirement account. To be eligible, you must have an HDHP, cannot be enrolled in Medicare, and cannot be claimed as a dependent on someone else's tax return.

What Are the Benefits of an HSA? 

HSAs offer several benefits, especially for individuals with high-deductible health plans. Here are the key advantages of an HSA:

HSA contributions can ultimately lessen your tax burden. If you make a certain amount of money a year and contribute a portion of those earnings to your HSA, you will only be taxed on the remaining amount that was not entered into the HSA. 

In addition to tax benefits, HSA plans have grown in popularity because they offer potential health care cost savings to both employers and employees. For example, individuals covered under an HSA are more likely to seek preventive care, choose generic drugs, not misuse the emergency room, and use online tools to research health care providers.

HSA Use Case Example 

Here's a real-world scenario of how someone might use an HSA:

Meet Sarah

• Age: 35
• Job: Marketing Manager
• Health Plan: Sarah has a high-deductible health plan (HDHP) through her employer, which qualifies her to open a Health Savings Account (HSA).

Scenario:

Sarah is generally healthy, but she wants to be prepared for any unexpected medical costs. She decides to contribute $200 per month to her HSA, which is deducted pre-tax from her paycheck.

Using the HSA:

• Annual Physical and Routine Doctor Visits: 
  • Sarah visits her doctor for her annual physical, which costs $150 out-of-pocket due to her high deductible.
  • She uses her HSA debit card to pay for the visit with tax-free dollars.
    
    
• Unexpected Medical Expense:
  • A few months later, Sarah sprains her ankle during a hiking trip. She needs X-rays, an ankle brace, and physical therapy, costing her a total of $800.
  • Fortunately, she has been steadily contributing to her HSA, and by the time the bill arrives, her account has enough to cover the entire cost without dipping into her regular savings.

• Dental and Vision Care:
  • Sarah also uses her HSA to pay for dental cleanings and new contact lenses, further reducing her taxable income and saving money on routine healthcare expenses.

Long-Term Benefits:

• By the end of the year, Sarah has used part of her HSA to cover medical expenses, but she also has leftover funds. These funds roll over to the next year, and since she doesn’t need to spend them right away, they continue to grow tax-free.
• As Sarah continues to contribute over time, she starts investing her HSA funds, allowing her account to grow for potential future medical expenses or even for retirement.

In this example, Sarah benefits from tax savings, immediate access to healthcare funds, and the ability to invest unused money for future needs.

What is an FSA? 

A Flexible Spending Account (FSA) is a tax-advantaged financial account that allows individuals to set aside pre-tax dollars to pay for eligible healthcare or dependent care expenses. FSAs are offered by employers as part of employee benefits packages.

Key Features of an FSA:

1. Pre-tax Contributions:
   • Employees contribute to an FSA directly from their paycheck before taxes, which lowers their taxable income.
2. Eligible Expenses:
   • FSA funds can be used for qualified medical expenses such as copayments, prescriptions, medical devices, dental and vision care, and even some over-the-counter items.
   • Some employers offer a Dependent Care FSA, which allows funds to be used for childcare expenses or eldercare.
3. "Use-It-or-Lose-It" Rule:
   • Unlike an HSA, FSAs have a "use-it-or-lose-it" policy. Generally, you must use the funds by the end of the plan year, or you forfeit the remaining balance. However, some employers offer a grace period or allow you to carry over a limited amount to the next year (up to $610 for 2024).
4. Employer-sponsored:
   • FSAs are set up by employers, and only employees can contribute (employers may contribute as well, but it’s less common). If you change jobs, you typically lose access to your FSA funds unless COBRA coverage is available.
5. Contribution Limits:
   • The IRS sets annual contribution limits for FSAs. For 2024, the healthcare FSA limit is $3,200, while the Dependent Care FSA limit is $5,000 per household.

Types of FSAs:

• Healthcare FSA: Used for qualified medical, dental, and vision expenses.
• Dependent Care FSA: Used for dependent care expenses, such as daycare for children or care for elderly dependents.
• Limited-Purpose FSA: Available for those with an HSA, this FSA can only be used for dental and vision expenses.

Example of Using an FSA:

Let’s say John has an FSA and contributes $2,000 for the year. He uses the funds for his regular dental cleanings, a new pair of prescription glasses, and his monthly prescription medications.

Since the money was taken out pre-tax, John effectively saves money on these medical expenses while lowering his taxable income for the year. However, if John doesn’t use the full $2,000 by the end of the plan year (or the grace period), he risks losing the remaining funds.

FSAs can provide immediate tax savings and help with budgeting for healthcare costs, but the "use-it-or-lose-it" rule requires careful planning.

Benefits of an FSA

Here are the key benefits of an FSA:

1. Tax Savings

• Pre-tax Contributions: Money you contribute to an FSA is taken out before federal taxes (and often state and payroll taxes), reducing your overall taxable income.
• Tax-free Withdrawals: Funds are not taxed when used for eligible medical, dental, vision, or dependent care expenses.

2. Immediate Access to Full Contribution

• Unlike some savings accounts, you have access to the entire annual contribution amount on the first day of the plan year, even if you haven't contributed the full amount yet. This can help cover large medical bills early in the year.

3. Covers a Wide Range of Expenses

• FSAs can be used for a broad variety of healthcare expenses such as copayments, deductibles, prescriptions, over-the-counter medications, medical supplies, dental and vision care.
• A Dependent Care FSA can cover costs related to childcare or elder care, which also provides tax savings for families.

4. Employer Contributions (Optional)

• Some employers may contribute to your FSA, further reducing the out-of-pocket burden for healthcare or dependent care expenses.

5. Predictable Budgeting

• Setting aside pre-tax dollars for an FSA can make budgeting for medical expenses easier, helping to ensure you have funds ready when you need them for healthcare or childcare costs.

6. No Impact on Health Coverage Eligibility

• FSAs can be paired with most health plans without affecting eligibility for health insurance benefits or other savings accounts, except for the Limited-Purpose FSA, which is designed for people with an HSA.

7. Some Flexibility with the "Use-It-or-Lose-It" Rule

• Though FSAs generally follow a "use-it-or-lose-it" policy, some employers offer a grace period of up to 2.5 months to use leftover funds or allow up to $610 to be carried over to the next plan year (for 2024).

FSAs are an effective way to save on taxes while planning for medical, dental, vision, or dependent care costs. However, it's important to plan contributions carefully due to the "use-it-or-lose-it" rule.

Difference Between FSA and HSA

The main differences between an HSA and an FSA revolve around eligibility, ownership, and flexibility. HSAs are for individuals with high-deductible health plans (HDHPs), offering tax-free contributions, growth, and withdrawals for medical expenses, and the funds roll over year to year. 

HSAs are owned by the individual and are portable across jobs, with investment options available. FSAs, on the other hand, are employer-sponsored, have a "use-it-or-lose-it" policy, and are not portable if you leave the job. 

FSAs provide immediate access to the full annual contribution but lack investment options and are generally more rigid in terms of changing contributions. Both offer pre-tax savings for healthcare costs.

The table below highlights the core distinctions between HSAs and FSAs, helping clarify their different uses, flexibility, and tax advantages.

Can I Have Both an FSA and HSA?

The answer is yes, you can have both an FSA and an HSA, but it depends on the type of FSA. 

Here's how it works:

1. General FSA:

• If you have a general-purpose FSA that covers all medical expenses (e.g., doctor visits, prescriptions), you cannot contribute to an HSA at the same time. The IRS does not allow this combination because you would have two overlapping tax-advantaged accounts for the same purpose.

2. Limited-Purpose FSA:

• You can have an HSA along with a limited-purpose FSA, which is restricted to certain expenses like dental and vision care. This FSA doesn't overlap with medical expenses, so the IRS allows you to contribute to both accounts.

Key Points:

• To contribute to an HSA, you must be enrolled in a high-deductible health plan (HDHP).
• The limited-purpose FSA provides some flexibility by allowing you to save for vision and dental expenses while still keeping your HSA for broader medical expenses.

So, if you want to have both, you'd need to ensure that your FSA is limited purpose.

Which Tax-Advantaged Healthcare Option is Right for Me?

It all depends on your needs. HSAs are more robust in the sense that all the money you put into them doesn't ever expire and you can utilize them to save money for the future. Though, a high-deductible health plan is a prerequisite, which may be a drawback for some individuals.

FSAs are a bit more restrictive and don't have the same long-term benefits as HSAs, but if you're looking for a way to more easily cover your medical expenses here and now, it may be the plan for you.

For more guidance and information regarding tax advantaged healthcare options, contact our team today.