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Health care and child care costs are often unavoidable, but using a tax-friendly account to cover certain expenses can help cushion the financial blow. Enter health savings accounts (HSAs) and flexible spending accounts (FSAs). While both allow you to use pretax dollars to save money, they aren't one and the same.
Some of the key differences between an HSA and an FSA come down to how they're structured. They also have specific rules regarding your ability to keep unused funds at the end of each plan year. Understanding how HSAs and FSAs function can help you figure out which one may be best for you.
What Is a Health Savings Account?
You can use an HSA to pay for qualified medical expenses that are excluded by your health insurance plan, like copayments, deductibles and coinsurance. The list of what you can purchase with HSA funds is wide-reaching and includes birth control, first-aid supplies and many over-the-counter medications. An HSA's tax benefits can also help save you money.
- Your HSA contributions are tax-deductible.
- Withdrawals made for qualified expenses are tax-free.
- HSAs can be structured as investment accounts that allow for tax-free growth.
Once you turn 65, you can use HSA funds for anything you like without being penalized. (Prior to this age, you'll get hit with a 20% penalty if you use it for non-qualified expenses.) However, you'll still be taxed on these withdrawals.
HSAs are often available as an employee benefit. Your employer might even contribute to your account. You can also open one independently through an authorized credit union, bank or other organization that manages individual retirement accounts (IRAs). HSAs usually come attached to a debit card for easy use.
To qualify, you can't be enrolled in Medicare or have anyone else claim you as a dependent. Other eligibility requirements include:
- You must have a high-deductible health plan. For 2021, a high-deductible health plan has a minimum deductible of $1,400 for individuals; $2,800 for families.
- You can't have additional health coverage. Special coverages such as long-term care, dental and disability are allowed.
What Is a Flexible Spending Account (FSA)?
Only available through employers that offer them, a flexible spending account is another tax-friendly way to cover certain medical expenses. FSAs extend beyond health care—some employers offer dependent care FSAs to help parents and caregivers reduce child care and elder care costs. Meanwhile, limited-purpose FSAs are geared toward vision and dental care expenses.
Some FSAs come with a debit card. Others require you to pay upfront, then get reimbursed afterwards. Your company may also contribute to your FSA as an employee benefit.
Now for the rub—FSA funds usually expire at the end of each plan year. Some employers offer a grace period (usually up to two and a half extra months) to use any remaining funds. Others may let you roll up to $550 into the new plan year. In this way, overfunding your FSA could come back to bite you. However, recent legislation gave employers the option of letting FSA participants roll over 100% of their unused funds from 2020 to 2021, and from 2021 to 2022.
Key Differences Between an HSA and an FSA
HSAs and FSAs are similar concepts, but there are distinct differences between the two. From varied annual contribution limits to the ability to roll over funds, you'll need to learn the differences when deciding whether an HSA or FSA may be right for you.
| Differences Between HSAs and FSAs | ||
|---|---|---|
| HSA | FSA | |
| Contribution limit for 2021 | $3,600 for individuals; $7,200 for families Those 55 and older can contribute an additional $1,000 | Health FSA and limited-purpose FSA: $2,750 Dependent care FSA: $5,000 for individuals and married couples filing jointly; $2,500 for married people filing separately |
| When you can modify your contribution rate | Any time | During open enrollment or whenever you experience a qualifying life event, like welcoming a child or getting married or divorced *In 2021, you can modify your contribution rate at any time. |
| Rollover ability | You can roll over 100% of unused funds from one plan year to the next. | Some employers provide a grace period of up to two and a half months to use the money. Others allow you to carry over up to $550 into the following year. *Going from 2021 into 2022, employers can allow participants to roll over 100% of their funds. |
| How you're taxed on withdrawals | Qualified expenses: Tax-free Non-qualified expenses: Taxed at ordinary income tax rate, plus 20% penalty; this penalty is waived upon turning 65 | Tax-free (cannot use for non-qualified expenses) |
| Eligibility | Must be enrolled in a high-deductible health plan Can't be claimed as someone else's dependent Can't be enrolled in Medicare | Must be offered by an employer |
Deciding Between an FSA and an HSA
The average non-elderly family in the U.S. spends 11% of their income on health care expenses, according to the Kaiser Family Foundation. HSAs and health FSAs are great ways to save, though you generally can't contribute to both during the same plan year.
Think about your average annual health care expenses, like your deductible, medications and doctor's visits. Other factors to consider include:
- Flexibility: If you meet the qualifying criteria, you can keep an HSA and continue contributing to it as you move through your career, regardless of who your employer is.
- Your retirement plan: Since an HSA can double as an investment account, it could serve as a nice addition to your nest egg.
- Your health insurance plan: While HSAs are limited to high-deductible health plans, FSAs have no such restriction.
The Bottom Line
While different, HSAs and FSAs are two types of tax-advantaged accounts that can reduce your out-of-pocket costs in the long run. Maintaining strong credit is equally important to your financial health. Experian has you covered, allowing you to check your credit score and credit report for free in a matter of minutes.