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HSA vs. FSA: What's the Difference, and Which One Is Right For You?

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Have you ever postponed a doctor visit because you dreaded paying for the inevitable onslaught of exams? It seems that every time I visit the doctor for a routine cold, I'm hit with a $150+ medical bill. Enough is enough! Today I'm sharing two tools that will help you manage out-of-pocket medical expenses so you actually feel good about getting the healthcare you need. There are two super compelling and tax-friendly ways you can save for doctor visits, prescriptions, surgeries, and any other medical expenses down the road. Let's break down the differences between a Health Savings Account (HSA) and a Flexible Spending Account (FSA).

What is a Health Savings Account (HSA)?

An HSA is a special savings account that allows you to set money aside for qualified medical expenses such as co-pays, coinsurance, and prescriptions. Here's the catch: you are only eligible for an HSA if you have a high-deductible health plan (HDHP). In other words, if you have a preferred provider organization (PPO) or other lower-deductible plan, this paragraph won’t apply to you. (If you're not sure which plan you have, check your health insurance card.) There are a few really great benefits to an HSA:

  • An HSA has a TRIPLE tax advantage. Here's how it works. (1) The money you put into your HSA is tax deductible. So if you fund $3,000 per year, you won't pay taxes on that money. (2) Your withdrawals are tax-free. So when you take out that $3,000, you still don't have to pay taxes on it. (3) Your money grows tax-free. If you invest the money in your HSA and it grows with time, your earnings aren't taxed, either! It's safe to say that an HSA is one of the most tax-friendly vehicles out there. The only caveat is that you MUST use your withdrawals for qualified medical expenses.
  • Your unused balance rolls over every year. With an HSA, there’s no “use it or lose it” risk. Your savings stay with you forever, even after you switch jobs or health plans. That means you can let your funds grow through compound interest and use them down the road for yourself, your kids, or your spouse.
  • Your employer may contribute to your HSA. We all like free money!

As with all great things, there are some restrictions to an HSA.

  • There are contribution limits. In 2018, individuals can only contribute $3,450 per year, and families can fund $6,900.
  • Most HSAs have a monthly maintenance fee. Your employer may cover this fee, but it’s something to look into.
  • Your investment options may be limited. You can invest the funds in your HSA, which can turbocharge growth over time. But if your employer contributes to your HSA, you may have to keep it with their pre-approved institution. Unfortunately, these tend to have fewer investment options. If your employer does not contribute to your HSA (or you switch jobs or coverage), then you can move it to another institution that has more options.

What is a Flexible Spending Account (FSA)?

Unlike an HSA, you can open an FSA no matter what type of healthcare coverage you have, as long as your employer offers it. An FSA is similar to an HSA in that it allows you to set money aside for medical expenses in a tax-advantaged way. Also, your employer can choose to contribute to it. After that, the two accounts look pretty different. Here are some of the key points.

  • Your FSA contributions and distributions are tax-free, but you can’t invest your funds. Remember that an HSA offers tax-free growth through investment earnings, and therefore a “triple” tax advantage. However, it wouldn’t even make sense to invest your FSA funds because you only have them for a short period of time. This leads into my next point…
  • Your FSA balance does NOT roll over every year. With an FSA, you should only fund what you think you’ll use that year. Otherwise, you’ll forfeit your balance at year-end. Pro tip: stock up on over-the-counter meds and personal care products at the FSA Store to spend your last-minute dollars!
  • FSA contribution limits are lower than HSA limits. You can only contribute $2,650 per year to an FSA in 2018. This may be a good thing, since you lose your remaining balance at year end anyway.

Should I choose an HSA or an FSA?

You can’t have both an HSA and an FSA, unless you have a limited-purpose FSA that only covers vision and dental. If you are eligible for an HSA, I would choose that option for a couple reasons. First, you can contribute more tax-free dollars. Second, your money rolls over every year, so you don't have to worry about losing it. If you are not eligible, then I would open an FSA. And definitely take advantage of the FSA Store if you need to use up your cash!

The more important decision is often between health plans rather than HSA vs. FSA. Some employers give you an option between a high-deductible health plan (plus an HSA) or something with a low deductible. It’s important to distinguish between the plans and determine which aligns best with your healthcare needs. Nerdwallet has a helpful post on choosing between a low- or high-deductible health plan.

The Bottom Line

There’s nothing more deflating than sifting through confusing health insurance jargon at work. If you're young and healthy today, you might be tempted to just blow off learning what it all means. But protecting yourself with basic healthcare coverage is a must, and saving for future medical expenses with an HSA or FSA is equally important. If you start preparing now, you'll definitely thank yourself later.

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