This article was updated on February 19, 2016.
Using tax-favored accounts to pay for vital expenses is a great way to save money by cutting your tax bill. With so many different accounts available, though, it can be hard to keep all of your choices straight. For instance, with medical expenses and other healthcare costs, many people can choose between a health savings account, or HSA, and a flexible spending account, or FSA. Yet how can you pick the better savings vehicle for your personal situation? Let's take a closer look at the HSA vs. FSA debate with an eye toward helping figure out which choice is better for you.
HSA vs. FSA: The numbers
Before weighing their relative merits, you should know what HSAs and FSAs are. Health savings accounts are designed to supplement the medical-expense needs of those who carry high-deductible health insurance policies, where you retain a substantial portion of the cost of your healthcare and have to pay sizable upfront deductibles for most expenses before your coverage kicks in. Contributions to an HSA are deductible on your taxes, and as long as you withdraw money for medical expenses for yourself or for qualifying members of your family, you don't have to pay any taxes on the amount withdrawn -- even if some of that money represents untaxed income and gains on the investments you hold within the HSA.
Flexible spending accounts are similar in many ways. FSAs are offered by your employer as a fringe benefit, and to participate, you can elect to have money withdrawn from your paycheck and deposited for use in your flexible spending account. The contributions you make are taken from your pre-tax pay, so you don't have to pay income tax on what goes into your FSA. Unlike HSA contributions, the money taken for use in your FSA is also free of payroll taxes, which for most workers saves another 7.65% in unpaid taxes. Again, if you use the money to pay qualifying medical expenses, you don't have to pay taxes on it when you withdraw it.
Both HSAs and FSAs allow employers to make contributions on your behalf. In some cases, employers will add money of their own in order to give you an incentive to use those arrangements, hoping that their efforts will pay off as you pay more attention to monitoring and controlling your healthcare costs.
Differences between HSAs and FSAs
Despite these similarities, there are some important distinctions between HSAs and FSAs. The biggest difference is that if you don't spend your FSA money for a year by a specific due date, then you can forfeit the unused portion. Recently, rule changes have allowed participants to use money for several months of the following year and to carry forward small amounts even further into the future, but not all employer FSA plans have adopted those provisions. It's therefore important not to save more than you think you'll use in an FSA.
HSA money, on the other hand, is eligible to carry forward as long as you want. In fact, many people use HSAs almost like a substitute for a retirement account, investing their contributions for the long run. Even if you have qualifying expenses, there's no requirement that you use HSA money to cover those expenses.
In addition, most FSAs don't allow investing. Money stays with your employer, where it sits until you're ready to use it. HSAs let you invest in a broader array of investments, ranging from ordinary bank accounts to mutual fund-like investment options from a number of financial institutions.
Finally, the contribution limits for HSAs and FSAs are different. HSAs allow you to deposit as much as $3,350 in 2016 for individual participants or $6,750 for those with family coverage. Those who are 55 or older can add another $1,000 to those limits. For FSAs, contribution limits of $2,550 apply.
How should you choose?
In many cases, you won't really have a choice between FSAs and HSAs, as you'll only have one option available. If you don't have a high-deductible health insurance plan, then an employer-sponsored FSA is your only potential option. If your employer doesn't offer an FSA, then you have to see if you can do an HSA on your own -- again assuming that you have a high-deductible health plan.
Overall, it can seem like a monumental task to figure out whether you can participate in an HSA, an FSA, or both. In the end, though, the tax savings can be well worth the effort.