HSA vs. FSA: Which Is Smarter for You?

Compare and contrast these two health-related benefits.

Dan Caplinger
Dan Caplinger
May 26, 2018 at 8:34AM
Investment Planning

Paying for healthcare costs is a challenge that workers have to overcome throughout their lives. Many employers offer a combination of employee benefits that can help their workers handle their healthcare finances more efficiently. Both health savings accounts (HSAs) and flexible spending accounts (FSAs) can offer valuable tax advantages to those who use them, but the two healthcare savings vehicles differ in many important respects. It therefore is important that, if you have access to both, you pick the one that matches best with your own needs.

How flexible spending accounts work

Flexible spending accounts are somewhat more common as employee benefits than HSAs. You can divert money into an FSA each year to go toward covering qualified healthcare costs. The primary benefit of FSAs is that the money that you deposit into your account goes in on a pre-tax basis, and you thereby avoid paying not only income tax, but also Social Security and Medicare payroll taxes on the amounts that go into the flex account.

You can make contributions to FSAs for healthcare purposes of up to $2,650 in 2018. As long as your employer provides a flex account framework, you're not required to have a certain type of health insurance plan in order to qualify for an FSA.

Finger pointing to hanging image of sign saying FSA.

Image source: Getty Images.

The primary disadvantage of FSAs is that there are limitations on whether or to what extent you're allowed to use the money for medical expenses beyond the current year. In general, if you have unused money left over in an FSA at the end of the year, you have to forfeit it to your employer. Nearly all plans give you time beyond the end of the year to submit those expenses, but they need to have been incurred before year-end.

Some exceptions to the forfeiture rules do apply. The more typical one gives employees an extra period of time at the beginning of the year to use up FSA money from previous years. A newer choice lets employers allow their employees to carry forward up to $500 in unused FSA money into the following year, instead. However, employers aren't allowed to offer both of these options to their workers, and there's no requirement that they offer either one. You'll need to talk with your HR specialist in order to get the final word on what applies at your job.

The basics of health savings accounts

Health savings accounts are special financial accounts that some people are able to use to set money aside to cover healthcare expenses. HSAs are always linked to what's known as a high-deductible health plan, or HDHP, which leaves the policyholder responsible for larger deductibles before coverage kicks in than ordinary health insurance policies. Only those who have such HDHP policies are allowed to make contributions to an HSA.

Piles of coins with letter blocks HSA on top.

Image source: Getty Images.

The biggest benefit of an HSA is that you get beneficial tax treatment in multiple ways. First, the money that you contribute on your own behalf is tax deductible up to a certain maximum amount each year. For 2018, the maximum contribution is $3,450 for self-only insurance coverage or $6,850 for family coverage. In addition, if your employer makes contributions to your HSA, that additional money doesn't count as taxable income to you. Finally, if you use the money for qualifying medical expenses, then any income or gains that the account produces is tax-free.

HSAs also provide some added flexibility. Unlike FSAs, HSA money is never subject to forfeiture, and you're allowed to carry over unused balances into future years with no limitation. Some people use HSAs as alternative retirement savings vehicles with the intent of letting money grow tax-free throughout their careers and only tapping into it once they face larger healthcare expenses in retirement. Whether you do that or simply use your HSA money as needs arise, the tax benefits from the accounts are worth the minimal effort in setting them up -- and if your employer adds contributions, you'd be giving up free money not to participate.

The best solution for you

If you're fortunate enough to be able to choose between an HSA and an FSA, the one that makes more sense for you depends on a combination of factors. Typically, you won't be able to participate in both types of accounts in the same year unless your employer offers what's known as a limited-purpose FSA that only covers ancillary expenses, like the costs of dental visits or vision services.

In general, if you know exactly how much your healthcare expenses will be and you expect to spend every penny of what you set aside, then an FSA will work marginally better. The extra benefit of avoiding Social Security and Medicare taxes is a small additional savings, and if your expenses are predictable, you never have to worry about forfeiting money in the account.

By contrast, if you don't know what your healthcare expenses will be, an HSA usually is the better choice. Being able to carry money into future years can be extremely valuable, and the higher annual contribution allowance also is a plus. If your employer adds money to your HSA on your behalf, that's a big bonus that really pushes the scales in the HSA's favor.

Most people will be fortunate if they have access to just one of these tax-favored accounts. If you can contribute to an HSA or FSA at work, it's definitely worth a closer look to see if it'll fit well with your personal situation.