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Medical expenses add up and anyway we can offset them is helpful. Fortunately, the government offers two tax-advantaged programs – the Health Savings Account (HSA) and Flexible Spending Account (FSA). While both are helpful, they have many differences and most people can’t carry both accounts.
We break down the Health Savings Account and Flexible Savings Account below so you understand the differences and can tell which one is right for you.
What is an HSA?
An HSA or Health Savings Account is a tax-advantaged account for individuals and families with a high deductible insurance plan. Not just any high deductible plan is eligible, though. The IRS determines which plans are eligible each year – always check with your insurance company, employer, or HR department to find out.
High deductible insurance plans typically have lower premiums which is a great advantage for some people. However, the out-of-pocket expenses required before the insurance begins can make a big difference in your budget.
A Health Savings Account is money you contribute pre-tax to use on eligible health expenses. The money also grows tax-free and you don’t pay taxes on withdrawals if you use the funds for eligible expenses.
You can open a Health Savings Account through your employer if they offer it or on your own if they don’t, and you have an eligible plan. You can open a Health Savings Account at a bank, credit union, or broker of your choice.
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What is an FSA?
A Flexible Spending Account is another tax-advantaged account for individuals and families to help cover medical expenses. You don’t need a high deductible insurance plan to qualify, but you can only get the plan through your employer – you can’t open one yourself.
Like the HSA, the FSA funds come out of your paycheck pre-tax, which lowers your tax liability. For example, if your paycheck was $1,000, but you contributed $200 to your Flexible Spending Account, you’d only pay taxes on $800, not $1,000.
Flexible Spending Account funds don’t roll over each year – you must use them or lose them. Some employers offer the option to roll funds over, but the IRS allows a maximum of $550 to be rolled over. You don’t pay taxes on withdrawals if they’re used for eligible medical expenses.
What are the Similarities?
You probably noticed some similarities between the HSA and FSA above. We’ll list them here to make it easier to understand.
- Pre-tax contributions for a lower tax liability
- Withdrawals are tax-free if used on eligible medical expenses
- Employers can offer the plans
- Money should be used on medical expenses not covered by insurance and/or out-of-pocket expenses
What are the Differences?
HSA and FSA plans also have many differences.
Health Savings Account:
- You can open an account through your employer or on your own
- You must have a high deductible insurance plan considered eligible by the IRS
- Your contribution limit is $3,600 a year for individuals and $7,200 for families
- You control your contributions throughout the year and can change them at any time
- You can rollover account balances year after year
- Your account can earn interest, dividends, or capital gains and not incur a tax liability if you use the money for eligible expenses
Flexible Savings Account
- You can only open an account through your employer
- You don’t need a specific type of insurance plan
- Your contribution limit is $2,750 per year
- Your account is pre-funded, and you can only change your contribution amount during open enrollment or a change in your status
- You can’t roll over account balances with a small exception of $550 if your employer allows it
- Your account doesn’t earn interest or earn dividends
Can you Have Both an HSA and FSA?
You can’t have both an HSA and FSA – it’s one or the other. The only exception is if your employer offers a limited purpose FSA, but this isn’t common.
Which is Right for You?
Choosing between a Health Savings Account and Flexible Savings Account is a personal decision. Initially, it comes down to what your employer offers if you’re employed. If you’re self-employed, your only option is an HSA if you find an eligible high deductible health insurance plan through the marketplace.
If you have the option for both accounts, consider the following.
- What do you expect your health expenses to be? If you and your family members are relatively healthy, taking the high deductible health insurance plan and HSA keeps your premiums lower and allows you to put money aside tax-free for your medical expenses. You can roll the funds over year after year, and even use the money in retirement, all while lowering your tax liability.
- If you have higher health expenses, you may want to choose a health insurance plan with higher premiums but a lower deductible. If you don’t take a HDHP you aren’t eligible for a Health Savings Account but can get some tax benefits by electing an FSA if your employer offers it. Just keep in mind, if your FSA is pre-funded and you leave your job, you’ll owe the balance of what you haven’t paid yet if your employer stretches the contributions out over the year.
Whether you choose an HSA or FSA, contribute the maximum amount you can afford and that the IRS allows. You can use the funds to cover your co-pays, deductibles, and out-of-pocket expenses. Even if you have a ‘great’ insurance plan, everyone has out-of-pocket expenses for things like dental care, vision care, and prescriptions.
Take advantage of the opportunity to save and lower your tax liability. Even a little money knocked off your income will keep more money in your pocket rather than you paying it to the IRS each year.