Healthcare is a key consideration within your financial plan, as these expenses can account for a significant portion of your spending. Even if you and your loved ones are in good health now, circumstances can change on dime and it’s difficult to predict what your needs will be down the road. Luckily, there are savings accounts specifically designed to help you cover these expenses, providing certain tax benefits that encourage you to save.
Two popular options are Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs). While both aim to help individuals save money for medical expenses, they differ in a number of key aspects. By understanding these distinctions, you can make a more informed decision about which of the two accounts better suits your needs.
How Do These Accounts Work?
Health Savings Accounts (HSAs) are tax-advantaged accounts for individuals with high-deductible health insurance plans that are funded with pre-tax dollars. The funds can be invested, potentially grown over time, and then withdrawn tax-free to pay for qualified medical expenses.
Flexible Spending Accounts (FSAs) are also funded with pre-tax dollars, but they’re typically offered by employers. The money in this account can be used to cover eligible healthcare costs but does not offer the same potential for investment growth.
If you could use a hand determining which option better suits your needs, we outline some of the key differences between these accounts that may bear consideration.
Eligibility
HSAs are only available to those enrolled in high-deductible health plans (HDHPs), so not everyone will be eligible to participate. Because of this requirement, those with more comprehensive health coverage, lower deductibles, or those who lack insurance altogether may not be able to fund an HSA. Conversely, FSAs are typically employer-sponsored and do not require a specific health insurance plan, making them accessible to a wider range of workers.
Rollovers & Contributions
One of the primary advantages of using an HSA over an FSA is that the funds within an HSA roll over from year to year, so the money you contribute to the account remains yours indefinitely. This rollover feature allows you to build a substantial balance over time that can be used to cover future healthcare costs.
FSAs, on the other hand, are subject to a “use it or lose it” policy. This means if you fail to use all of your FSA funds within the plan year, you lose the remaining balance. There are some exceptions, though. Employers have the option to offer a grace period of up to 2.5 months after the end of the plan year for employees to use their remaining FSA funds. Alternatively, they can allow employees to carry over up to $550 of unused funds into the following year. Employers can offer one of these options or neither – they cannot offer both.
HSAs also tend to have higher annual contribution limits than FSAs, allowing you to earmark more funds for healthcare expenses each year. These limits are adjusted each year to comply with IRS guidelines.
Ownership & Portability
HSAs are personally owned, so your account will remain with you even if you change jobs or retire. You can continue growing your account and using the funds within it for qualified medical expenses. Since FSAs are employer-owned, you risk forfeiting the remaining balance of your account when you leave your employer unless you’re eligible for continuation through COBRA. For this reason, HSAs are considered portable while FSAs are not.
Investments
A unique perk of HSAs is the opportunity to invest your funds, potentially growing your account balance over time. Similar to an IRA, 401(k), 529 College Savings Plan, or another tax-advantaged account, you can invest in a variety of securities like stocks, bonds, and mutual funds. This feature can make HSAs useful tools for investment growth, allowing your contributions to appreciate until you need to access them down the road. FSAs owners are not afforded the same investment opportunity.
Tax Benefits
Both accounts offer tax advantages, but the HSA provides a triple tax benefit: contributions are made pre-tax (and therefore entitle you to an income deduction), earnings and growth are tax-free, and withdrawals for eligible expenses are also tax-free. Withdrawals for non-eligible expenses may incur income taxes plus an additional 20% penalty. With FSAs, contributions are pre-tax, and withdrawals for eligible expenses are tax-free.
Another lesser-known benefit of investing in an HSA is you can withdraw funds penalty-free for any reason after turning 65. You will have to pay income taxes on the withdrawal if the funds aren’t used for qualified medical expenses, but you won’t be subject to the 20% penalty. In this way, an HSA can function similarly to a traditional IRA as a retirement savings vehicle.
Conclusion
Both HSAs and FSAs can be valuable tools for managing healthcare expenses and can provide certain tax advantages for saving. An HSA offers more flexibility with higher contribution limits, rollovers, and the ability to invest, but they’re only available to those with high-deductible plans. FSAs, while providing lower contribution limits and a “use it or lose it” structure, are accessible to a wider range of people.
Choosing between an HSA and an FSA depends on your individual circumstances, including your health plan, financial situation, and long-term needs. Understanding these differences can help you make the best decision for your healthcare and financial wellness. Consider speaking with a financial advisor or benefits specialist to get personalized advice.
Best,
Robert (Rory) J. O’Hara III, CFP®, CRPC®
Founder I Senior Managing Partner
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