When it comes to health insurance, there are two popular ways to save money to pay for qualified medical expenses: a flexible spending account (FSA) and a health savings account (HSA). What’s available to you depends on your health insurance and what your employer offers. The accounts have different rules, along with distinct advantages and disadvantages. Here’s the breakdown.
What You Need to Know
Both an HSA and FSA allow you to save pre-tax income to pay for eligible medical expenses.
You must have a high-deductible health plan (HDHP) in order to open an HSA.
Your entire HSA balance rolls over from year to year, while the bulk of FSA savings usually do not.
What Is an HSA?
An HSA is a tax-advantaged account that allows you to save pre-tax money to pay for qualified medical expenses. You contribute pre-tax money into an HSA for your medical bills, just as you may contribute pre-tax sums into a 401(k) for retirement. If you use the money for eligible medical expenses, you also don’t pay tax when you withdraw the funds. In order to save to an HSA, however, you must enroll in a high-deductible health plan (HDHP). In 2020, the average HDHP deductible for an individual was around $2,500 and $5,000 for a family.
Contribution limits to an HSA are as follows1:
- In 2020, individuals with self-only health plans can save up to $3,550, and those with family plans could save up to $7,100. Over age 55, you can save an additional $1,000.
- In 2021, the self-only plan limit is $3,600, and the family plan limit is $7,200. The over-55 “catch-up” contribution remains $1,000.
What Are the Benefits of an HSA?
An HSA offers several benefits:
- The money is tax-free. The money you save to an HSA is either pre-tax (out of your paycheck at work) or deductible on your own income taxes (you can deposit money and take a deduction at tax time). Either way, you lower your taxable income for the year.
- You can save long-term. The money you save to an HSA can be rolled over, year to year.
- It’s portable. You own your HSA. When you leave a job, your HSA and the money inside it go with you. That said, you can’t continue contributing to it unless you remain enrolled in an HDHP at your next job.
- You may be able to invest your savings. Some HSAs offer you the ability to invest the money you’re saving. Plus, any earnings are tax-free.
- Your employer may contribute. Roughly two-thirds of employers2 offer HSA contributions, whether or not you contribute. (The average employer contribution in 2018 was $839.)
- You can change your contribution. If circumstances change during the year, you can bump your contribution up or down accordingly. If you’re contributing via a payroll deduction, check with your human resources department to ask how to change your contributions. But you can also usually make non-payroll contributions via your account online. Changes can be made anytime during the year, and you can usually make contributions up to the April tax deadline for that tax year.
What Are the Drawbacks of an HSA?
There is one main drawback of an HSA: You must have an HDHP in order to establish an HSA. While HDHPs tend to carry lower premiums than health insurance plans with lower deductibles, a high-deductible plan isn’t the best choice depending on your health history.3 You pay out-of-pocket until you meet your deductible and your insurer begins chipping in. If you have a chronic condition or you’d have trouble covering the deductible, a different kind of health plan may be best for you.
Good to Know
Both a health savings account (HSA) and a flexible spending account (FSA) provide valuable ways to save money by allowing you to use pre-tax savings to pay for medical expenses.
What Is an FSA?
An FSA4 is an employer-sponsored savings plan where you can save pre-tax money for medical expenses that aren’t covered by your health insurance. An FSA is an employee benefit, so your company must offer an FSA for you to participate.
What Are the Advantages of an FSA?
There is one big advantage to an FSA: You can contribute up to $2,750 a year tax-free. Like an HSA, your contribution to an FSA comes out of your paycheck before taxes, so you lower your taxable income. Also, as long as you use your savings to pay for qualified medical expenses, there are no tax penalties on withdrawals.
What Are the Drawbacks of an FSA?
There are a few disadvantages to this kind of account:
- Your FSA balance doesn’t roll over year to year. Even though you are contributing pre-tax salary into the account, your employer owns your FSA. Whatever salary contributions you don’t spend on qualified medical expenses within your plan year, goes back to your employer5. That’s like paying your boss for the privilege of an FSA. There are two limited exceptions: Your employer may offer you a grace period beyond the plan year or may allow you to roll over $550. With a grace period, you have two and a half months after the end of the plan year to use the funds. With a rollover option, you can roll over as much as $550 from year to year. Any funds in excess of that go to your employer.
- It’s not portable. Generally, if you leave your job, you lose your FSA and your balance at the time you depart.
- Contributions are set once a year. You typically choose your FSA contribution amount for the next plan year during your company’s open enrollment period, and the amount can’t be changed after that unless you have a qualifying life change (such as a marriage or birth).
2020 Caveat: Due to the COVID-19 pandemic in 2020, the IRS made temporary changes to FSA rules6. In 2020, employers could allow employees to change their FSA contribution amount mid-year. The IRS also extended the grace period in which employees can use carried-over money from 2019 to December 31, 2020.
Did You Know?
Your employer controls the availability of an HSA or an FSA, and other health insurance rules also apply.
What Are Qualified Medical Expenses?
You can use the funds from an HSA or FSA to pay for medical, vision, and dental expenses incurred by you, your spouse, and anyone you claim as a dependent on your tax return. This would include things like acupuncture, prescription drugs, and contact lenses, as well as copays and other payments for medical services7. In 2020, this list includes expenses for over-the-counter medications and menstrual products. For a more detailed list, see IRS Publication 502, Medical and Dental Expenses.
HSA vs. FSA
In general, an HSA is more flexible than an FSA, and you can set more money aside. You can roll the money over year to year, and you keep your HSA even if you change jobs. That said, you must have an HDHP in order to participate. Here’s the comparison:
| HSA | FSA | |
| Eligibility | You must be covered by a high-deductible health plan. | Your employer must offer an FSA benefit. |
| Contribution limit | For 2020, up to $3,550 for individual coverage and up to $7,100 for family coverage For 2021, up to $3,600 for individual coverage and up to $7,200 for family coverage If you are 55 or older, you may add up to $1,000 as a catch-up contribution. | You may contribute up to $2,750 per plan year, and your employer may allow you to contribute less. This applies for 2020 and 201. |
| Long-term savings | Yes | No |
| Tax deductible | Yes | Yes |
| Rollover rules | HSAs roll over every year. | FSA money must be used within the plan year, though some employers may grant a brief grace period or up to a $550 rollover. |
| Withdrawal rules | You can withdraw funds for eligible medical expenses incurred after you establish the HSA. Withdrawals for other reasons will be subject to income tax and potentially a 20% penalty. | Distributions from an FSA are only allowed for eligible medical expenses, and you’ll need to provide a receipt or third-party written statement indicating the amount of the expense and that it wasn’t covered by your health plan. |
| Goes with you if you change jobs | Yes | No |
| Change contribution | Yes. If contributions are coming out of your paycheck, check with your employer to understand how to change this at any time. You can generally make changes to non-payroll contributions via your online account management tools. | No (although temporarily, in 2020, you can change your contribution once if your employer allows it) |
Next Steps
Both an HSA and an FSA provide valuable ways to save money by allowing you to use pre-tax money to pay for medical expenses. If you have questions about whether an HSA or FSA might be available and right for you, contact your human resources department or consult a financial planning professional.
