Think fast: If asked to explain the difference between health savings accounts (HSAs) and flexible spending accounts (FSAs), would you really know the answer?

Many of us don’t. While HSAs and FSAs are both tax-advantaged options available through work benefits and share other similarities — including very similar names — there are important differences. Here’s what you should know when it comes to the difference of an FSA vs. HSA so you can decide which account is right for your and your family.

WHAT IS AN HSA?

A health savings account (HSA) is a tax-advantaged account that allows you to save for medical expenses. With an HSA, you (and your employer) contribute pre-tax dollars, which you can then use to cover qualified medical expenses. Because your contributions lower your federal taxable income, you can stretch your money further.

The catch: Not everyone can contribute to an HSA. In order to qualify, you must be enrolled in a high-deductible health plan (HDHP). For 2020, these health plans are defined as having a minimum annual deductible of $1,400 for an individual plan and $2,800 for a family plan. In addition, yearly out-of-pocket expenses can be no more than $6,900 for an individual and $13,800 for a family plan. Other eligibility requirements include that you have no other health insurance, that you are not enrolled in Medicare, and that you cannot be claimed as a dependent on someone else’s tax return.

Individuals can contribute up to $3,550 annually to their HSA (for 2020) or $7,100 for a family plan. Once the money is in the account, it’s yours to use whenever you’d like (as long as it’s spent for qualified healthcare expenses) and it can grow from year to year.

HOW DOES AN HSA WORK?

If you qualify for an HSA, you can typically fund it directly from your paycheck with pre-tax funds (your employer can also make contributions). You can then use the money to pay for qualified medical expenses, including:

  • Doctors visits, deductibles, and copays

  • Counseling services (such as therapy)

  • Prescription medications

  • Medical supplies such as bandages, gauze, etc.

  • Eyecare (such as glasses and contact lenses)

  • Dental care (such as braces and dentures)

  • Orthotics and more

If you use HSA funds for anything not deemed a qualified medical expense, you will pay a penalty, as well as income taxes on the funds.

Some people choose to invest a portion of the money in their HSA, allowing it to grow over time — then use the money for healthcare in retirement. This strategy has a triple-tax benefit because the money goes into the account tax-free, it grows tax-free, and you can withdraw it tax-free if it’s used for qualified medical expenses.

WHAT IS AN FSA?

A flexible spending account (FSA), also occasionally called a flexible spending arrangement, is a tax-advantaged account that is used to reimburse you for qualified medical expenses. Like an HSA, an FSA can be funded by both you and your employer. The money goes into the account tax-free.

FSAs are established by an employer; in order to qualify for one, your employer must offer it in your benefits package. Just like with an HSA, there are limits to how much you can contribute to an FSA. In 2020, your contribution is capped at $2,750.

Unlike the funds held within HSAs, you typically must spend money contributed to an FSA. For the most part, you must spend your FSA contributions in the tax year that you or your employers makes the contribution. But there are some cases where some or all your unused funds may rollover for a portion or all of the following year.

HOW DOES AN FSA WORK?

You typically sign up for your FSA during your open enrollment period, and you determine how much to contribute. Because the funds in your FSA expire, you should put in about what you plan to spend.

In order to use the funds, you must first pay for the qualified expense and then submit a claim. Once the claim is approved, you get reimbursed.

CHOOSING THE RIGHT ACCOUNT FOR YOUR NEEDS

In some cases, you might be able to open both an HSA and FSA. This is typically only allowed when the FSA is deemed “limited purpose,” which means that it can only be used for qualified dental and vision expenses and not general medical expenses.

It’s more common that you can choose between an HSA or FSA. All other things being equal, the HSA is likely the better option. That’s because the accounts offer similar tax advantages, but funds in an FSA must be spent each year, whereas you can let funds in an HSA grow over time. That can be particularly beneficial if you’re young and have low healthcare expenses. In that situation, an HSA can allow you to set aside funds now that you can use for future medical costs.

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