HSA vs FSA: which is better?
The age old debate – which should I use, a Health Savings Account or a Flexible Spending Account? Maybe both? Each person’s health care situation is different with different needs and objectives. The goal of this article is to educate you on the similarities and differences so that you can choose the plan that makes sense for you and your family. But the name of this site may provide a hint as to which (I feel) is superior.
Flexible Spending Account defined
A Flexible Spending Account (technically, Arrangement) or FSA is an employer established benefit plan that allows employee and employer contributions to a tax advantaged account to offset the cost of medical expenses. Contributions and distributions to/from the account are tax deductible if they are used for qualified medical expenses. FSA monies generally expire at the end of the year, sometimes with a 3 month grace period or maximum amount ($500) allowed to be rolled over.
Health Savings Account defined
A Health Savings Account or HSA is a tax advantaged account managed and owned by the individual used for medical expenses. Only individuals with certain types of insurance (High Deductible Health Plans, or HDHP’s) are allowed to open HSA’s. Monies contributed to, or distributed from, HSA’s are tax deductible if they are used for qualified medical expenses and have advantages if saved for retirement. HSA funds are owned by the individual, can be invested, and remain theirs forever.
Differences between HSA and FSA
While they sound similar, there are subtle differences between Health Savings Accounts and Flexible Spending Accounts and how they operate.
|Established by||Employer||Employer or Individual|
|Type of Insurance?||Any or none||HDHP only|
|Managed by||Employer||HSA holder|
|Contribution Amount||Determined at enrollment||Determined during year|
|Contribution available||Immediately||As contributions occur|
|Contribution method||Deducted from paycheck||Deducted from paycheck or contributed post tax|
|Contribution Limit||$2,550||$3,400 / $6,650 (single / family)|
|55+ Contribution Amount||none||$1,000|
|Ideal Contribution||Amount you will spend that year||max Contribution Limit|
|Unused Contributions||Expire at year end||Yours forever|
|Prior Year Contribution||No||Yes|
|Employee leaves job||Unspent contributions lost||Takes HSA with them|
|Tax reporting||none||IRS Form 8889|
As you can see, the list is long and there are some key differences there. Overall, HSA’s appear more flexible and offer more options for how you manage those contributions long term.
Similarities of both HSA’s and FSA’s
Being government sponsored and tax friendly accounts, both Health Savings Accounts and Flexible Spending Accounts share some similarities in how they operate.
|Employee Contributions||Yes, optional||Yes, optional|
|Payroll Contributions||Yes||Yes (optional)|
|Tax Deductible||Yes, if spent on Qualified Medical Expenses||Yes, if spent on Qualified Medical Expenses||Can be spent on||Qualified Medical Expenses per IRS 502||Qualified Medical Expenses per IRS 502|
Advantages of HSA over FSA
There are many advantages of a Health Savings Account over Flexible Spending Accounts, and I believe it to be the better plan all things considered. The biggest one is that HSA contributions are yours forever, no matter if you change jobs, change insurance, get fired, get old, retire, or what have you. They are yours to keep and can be spent on qualified medical expenses in a tax free manner at any time (or year) your wish. That is huge because you worked hard for that money, you shouldn’t forfeit it because the year changed. The fact that HSA contributions remain yours have other benefits, too. It provides flexibility to spend them as you need them, not try to cram all of your spending into the given year. You can save them for a rainy day, and even invest and grow your HSA. Once you turn 65, your HSA can be spent on whatever you want without penalty (you just pay tax on it, which you would have paid anyway). Hopefully at that point, your tax rate is low and and your HSA has grown for many years tax free. In this way, it is similar to a 401(k) or IRA investment account
Advantages of FSA over HSA
Notice in the “Differences” chart that the Contribution Available row for FSA says “Immediately”. That is because employers actually make the full year’s FSA contribution at the beginning of the year, and you pay them back every paycheck throughout the year. So for example, if you elect to contribute $24 to your FSA, on January 1st the employer puts $24 in your FSA. That money is immediately available and you can go out that day and spend $24 on a copay (for example). The advantage is the employee gradually “pays back” the contribution through the year, which smooths the contribution and doesn’t take so much out of pocket. So in each bimonthly paycheck that year you pay back $1, which is a huge cash flow advantage.
This advantage can (perhaps nefariously) be taken a step farther. With an FSA program, employers take on the risk of gain or loss with each employee’s FSA account since they make the full year contribution at the beginning of the year. This is because employees can leave or be terminated throughout the year. This occurs because 1) employees are not required to pay back spent but not contributed FSA amounts, and 2) employees do not receive FSA benefits that are contributed but not spent. This is best illustrated with some examples:
1) Employee wins
Let’s assume that John signs up for an FSA and contributes the full amount for 2015, $2,550. This amount goes into his account immediately at the beginning of the year, so on January 1st his employer contributes $2,550 to John’s FSA. Per the FSA, John agrees to contribute $2,550 over the course of the year, so John will have $106.25 deducted from each bimonthly paycheck. Let’s say on January 4th John has a surgery and uses his full FSA to pay for it. His account is now at $0, he has spent $2,550 and has contributed $0. On January 7th, John gets an offer from BigCorp and decides to leave his FSA employer. Guess what – John does not owe back the FSA amount of $2,550. Employees are not responsible for making up FSA amounts spent but not contributed You read that right, as John gets away free and the employer takes it on the chin.
2) Employer wins
However, the reverse is also true. Assume Paul elects to contribute the full amount of $2,550 to his FSA for 2015. Paul is healthy and doesn’t spend anything through December, and has diligently contributed $106.25 from each paycheck. He has an FSA with $2,550 available to spend and has personally contributed something like $2,444 as of December 15th. The next day, his company BigCorp lays off John unceremoniously just before the holidays. Unfortunately, John is given no warning and cannot spend the $2,550 in his account. This amount will expire when he is terminated and all of that money he contributed is lost. Ironically, the employer recognizes this unearned money as a gain.
Choosing between an HSA and FSA
As you can see above, there are many factors that apply to Health Savings Accounts and Flexible Spending Arrangements. Some of those may apply to your situation, and some may not. You will probably give some factors different weight in your decision than I do in mine. That said, here are some general guidelines in choosing between an HSA and FSA. [Note that you generally cannot contribute to both an HSA and FSA in the same year unless your FSA is a limited-purpose, or HSA compatible, FSA].
- All things equal, choose the HSA. You will thank me later.
- If there is money on the table, that should weigh heavily. If your employer is generous enough to contribute to a program free of charge to you, that is probably a good choice to make.
- Choose an HSA if your spending is long term. If you are considering contributing amounts close to the max of either plan, the HSA will allow you to keep those amounts and roll them over year over year.
- If your only option is FSA, choose it, but contribute wisely. You definitely still want a tax advantaged plan for your medical spending, and an FSA will do this. However, be very cautious over contributing to an FSA as you will lose that money at year end (or be forced to buy a bunch of stuff you don’t really need).
Note: if you do go with an HSA, please consider using my service TrackHSA.com to manage your Health Savings Account. You can store purchases, receipts, and reimbursements securely online.