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HSAs vs. FSAs: Which is Best for You?
As inflation touches nearly every facet of our lives, healthcare costs — as you can imagine — have been impacted significantly. In the United States, spending on healthcare grew 2.7% in 2021, reaching $4.3 trillion overall, which breaks down to $12,914 per person, according to the Centers for Medicare & Medicaid Services.
Unfortunately, those costs will likely only grow as we age. This is why it’s vital for us to tuck away as much as possible — as strategically as possible -– during our working years. There are a few ways we can do this, including using Health Savings Accounts (HSAs) for both short-term needs and long-term needs and health care Flexible Spending Accounts (FSAs) for short-term ones only.
It’s important to know the difference because, in general, you have to choose. You can’t use both an HSA and a health care FSA simultaneously (although if you have an FSA for dependent care expenses, they can overlap). Here’s a look at the biggest differences between the accounts and which may work best for you.
The Main Differences
The biggest difference between a healthcare-focused FSA and an HSA is: Your HSA rolls over from year to year while an FSA doesn’t. That means people with an FSA must “use it or lose it” and only put a certain amount of cash into the account they know they’ll spend within a calendar year. HSAs don’t have this regulation, so you can invest up to the allotted dollar limit every single year until you’re ready to use it.
So why isn’t everyone jumping on the HSA bandwagon? Not everyone qualifies. To be eligible, you must have a high-deductible health insurance plan. For 2023, that’s defined as a health plan with an annual deductible of not less than $1,500 for individual coverage or $3,000 for family coverage, according to the IRS, noting that annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) don’t exceed $7,500 for individuals or $15,000 for family coverage. You can get an HSA through your employer (although the account is owned by the individual and it’s portable — you can take it with you if you leave your job) or you can open one on your own. Eligibility for an FSA means working for an employer who offers one.
What They Have in Common
- Contributions to HSAs and FSAs are not taxed. If you fund an HSA or FSA through your employer, the money is taken out of your paycheck and deposited into the account before taxes are taken out. If you set up and contribute to an HSA independently and not through an employer, your contributions are tax-deductible.
- The government limits how much you can save in HSAs and FSAs. (In 2023, the Internal Revenue Service’s contribution limits for an HSA are $3,850 for singles and $7,750 for families. In 2023, the cap on contributions for FSAs is $3,050 for individuals.)
- The IRS requires you to spend HSA and FSA money on qualified out-of-pocket medical expenses. And withdrawals to pay for qualified medical expenses are tax-free. But, you’ll pay a penalty (and taxes) if you use the money on non-qualified items. The exception is once you’re age 65 or over. Then, although you’ll still be taxed on HSA withdrawals, you can use the money for anything penalty-free.
Other Ways They Are Different
- You can invest money in an HSA in different investments (mutual funds, CDs, bonds, even stocks). Note: Not all HSAs offer investment options. So, if this is something you’re interested in, make sure the firm you choose has investments on the menu.) FSAs have no investment component, and your savings earn no interest.
- As stated previously, the FSA has “use it or lose it rules” — if you don’t spend the money in the account within the year, you typically lose it. Some employers stretch the expiration date into the first few months of the following calendar year. Check with yours to make sure you know your deadline.
- You’ll never lose your money in an HSA. There are no “use-by” deadlines. According to HSA rules, you can leave the money in the account as long as you’d like. The IRS doesn’t even require you to take required minimum distributions in retirement.
- Contributions to an FSA must take place during the calendar year (January through December). HSA contributions are allowed from January through the tax due date the following year.
HSAs Can Be Used For Retirement, Too
While an HSA can be used to cover medical expenses throughout your lifetime, it’s also a savvy way to stow away cash for retirement. Unlike other investment vehicles that are taxed at various points along the way, your HSA money is always your money — tax-free! The genius of using an HSA is that you save your money pre-tax, invest it tax-free, and even withdraw it tax-free for eligible healthcare expenses. That’s why if you can afford it, you should contribute the maximum yearly to your HSA.
And while we’re on the topic of retirement, if you’re looking for more ways to save (and guidance on how to do it), then check out FinanceFixx from Jean Chatzky at HerMoney. It’s an 8-week budgeting course where you’ll be paired with a financial coach who can help guide you on your financial planning journey
The Bottom Line
As healthcare costs continue to rise, protecting the rest of your wealth becomes even more critical. For medical care, you want your first line of financial defense to be your HSA, not the money in your IRAs and 401(k)s. That’s why having a pool of money earmarked for medical expenses can spare your other accounts from taking an unnecessary hit and help your retirement savings last longer.
- CATEGORIES: Financial Education