HSA vs. FSA for qualified medical expenses

The Difference Between HSA and FSA for Medical Expenses

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There’s nothing more deflating than sifting through confusing health insurance jargon on your first day of work. Doubly discouraging is the fact that this is actually important stuff! We know basic healthcare coverage is a must. But proactively saving for future medical expenses is also important. To make this topic manageable, let’s break down the two tax-advantaged ways we can save for qualified medical expenses. Here’s what you need to know about a Health Savings Account (HSA) and a Flexible Spending Account (FSA).

Health Savings Account (HSA)

An HSA is a special savings account that allows you to set money aside for qualified medical expenses such as copays, coinsurance, and prescriptions. 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. There are a few really great benefits to an HSA:

  • An HSA is triple tax advantaged. The dollars you contribute are tax deductible (like a 401(k)), your withdrawals are tax-free (like a Roth IRA), and your money grows tax-free. That means you can invest the dollars in your HSA, and those earnings aren’t taxed. 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 2017, individuals can only contribute $3,400 per year, and families can fund $6,750.
  • 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. I mentioned that 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 the 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.

Flexible Spending Account (FSA)

Unlike an HSA, you can open an FSA no matter what type of 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 contributions and distributions are tax-free, but you can’t invest your funds. Remember that an HSA provides tax-free growth and investment earnings, and thus 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 $2,600 per year. 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 will 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

Have you ever postponed a doctor visit because you dreaded paying for the inevitable onslaught of exams? Enter the HSA and FSA. Both options help manage out-of-pocket medical expenses so you feel good about getting the healthcare you need. When you can swipe a debit card that doesn't actually link to your personal checking account, heading to the pharmacy or doctor's office doesn't feel so bad.

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