Key Differences, How to Choose

• HSAs and FSAs are both ways to set aside pre-tax income to pay for health-care expenses.
• HSAs are only available to those with a high-deductible health plan (HDHP).
• FSAs are paired with traditional preferred provider organization (PPO) health insurance plans.

Health-care expenses are among the biggest and most stress-inducing parts of a household budget. The US Centers for Medicare & Medicaid Services estimates that health-care costs average more than $12,500 per capita.

One way to help soften the financial blow is to set aside pre-tax income to pay for health care using either a health savings account (HSA) or flexible spending account (FSA), which many employers offer as part of their health benefits packages.

Though there are similarities between the two, they’re not the same. Here’s what they are and how you can use each of them to save money.

Health savings account vs. flexible spending account: At a glance

HSAs and FSAs are both tax-advantaged plans that allow consumers to save money for eligible health expenses. However, they pair with different types of insurance plans.

• An HSA is a savings account paired with a high-deductible health plan (HDHP) where money is contributed tax-free for eligible medical expenses. It earns interest in investments and rolls over from year to year. It has a higher allowable contribution amount than an FSA. 
• An FSA is a savings account that works in tandem with a traditional preferred provider organization (PPO) or health maintenance organization (HMO) insurance plan.
  The entire amount that you elect to contribute is deposited in the account at the beginning of the year, with any unused money forfeitable to the employer at the end of the year.

What is a health savings account?

An HSA is a savings account that allows employees to contribute pre-tax dollars for qualified medical expenses. Contributions can be rolled over from year to year and are not forfeited to the employer if left unused by the end of the plan year.

An HSA can be sponsored by an employer, or one can be opened by an individual as long as they have a high-deductible health plan. 

Tax savings

One of the strongest aspects of an HSA is the significant tax savings consumers get from participating in a plan. Advisors tout the triple tax advantage an HSA offers. 

• Contributions reduce taxable income
• Earnings grow tax-free
• Distributions for medical expenses are tax-free

Advantages of an HSA over an FSA

There are several advantages that an HSA offers over an FSA: 

• Funds can be invested. The HSA is structured as an investment account, which means the amounts invested in an HSA can have earnings. These earnings grow tax-free. 
• You don’t lose HSA funds. The HSA can be rolled over from year to year. The funds do not have an expiration date and you can take the account with you from employer to employer. 

• Higher contribution limits. Contribution limits for an HSA are much higher than they are for an FSA. The limits for 2022 are $3,650 for an individual or $7,300 for a family. That compares with a maximum of $2,850 allowable for an FSA. 

This chart summarizes the main pros and cons of an HSA:

Example of how an HSA can save you on health-care expenses

The power of an HSA is largely in its potential tax savings. Financial advisors tout the triple tax advantage that an HSA offers: tax-free contributions, tax-free growth, and tax-free distributions. Take, for example, a worker who earns $70,000 and files a joint tax return with their spouse and contributes the maximum of $7,300.

First, their gross income is reduced by $7,300. This brings their gross income down to $62,700. After subtracting the standard deduction amount of $25,900, the taxable income comes down to $36,800. The federal taxes on this amount are $4,005, which is $876 less in taxes they would pay had they not contributed to an HSA.

Meanwhile, the $7,300 can be invested. If it earns an 8% return, the account will earn $584 after a full year. Add your tax savings ($876) plus your investment earnings ($584) and you have $1,460 back in your pocket in just one year. And if they don’t use those funds for health-care expenses, they can continue to grow exponentially through the power of compound interest.

The big bonus is that these funds can be used for health care without being taxed as income — a potential 20% savings on

income tax

. This is particularly beneficial as health-care costs are probably the biggest single expense you’ll face in retirement.

What is a flexible spending account?

An FSA is offered by an employer in conjunction with a PPO or HMO insurance plan. The money can be used over the plan year for certain out-of-pocket health-care costs, such as deductibles, co-payments, prescriptions, medical equipment, and other qualified medical expenses.  

Employees can pay for eligible medical expenses with a debit or credit card issued for the account. They can also pay with their own money and then submit receipts for reimbursement. 

Employees have full access to the entirety of the funds at the beginning of the plan year. Accounts are filled at the beginning of the year with the full amount employees elect to have withdrawn. The payroll deduction amount will remain the same for each pay period throughout the year.

To participate in an FSA, the employer must offer it, and the employee must be enrolled in a traditional PPO or HMO plan. Flex account funds are limited to $2,850 for 2022. 

Contributing to an FSA reduces an employee’s overall taxable income, but the funds are “use it or lose it. That means your employer can keep any unused funds at the end of the plan year.

Advantages of an FSA over an HSA

There are several advantages that an FSA offers over an HSA. 

• Continued use of a traditional health insurance plan. One of the main advantages that an FSA has over an HSA is it pairs with a standard health insurance plan. Participants who have regular or planned medical expenses may wish to continue traditional insurance coverage, but they are not able to have an HSA in conjunction with it. 
• Immediate use of yearly funds. Another benefit of an FSA is all of the funds are deposited into the employee’s account at the beginning of the plan year. If an employee elects to contribute $2,000 for the year, you’ll have access to $2,000 on day one of the plan year. This can make a lot of sense when you have a larger health expense, such as a teenager who needs braces.
• Fewer disqualifiers. FSAs have fewer rules when it comes to who can use them. “HSAs have some pesky rules,” says Christopher Smith, from consumer finance expert Clark Howard’s team at Clark.com. “You must be enrolled in a high-deductible health plan to participate in an HSA program. If you have a large family with a lot of medical visits, that may not be ideal. HSAs also disqualify you if you’re eligible for Medicare or if you’re a dependent on someone’s taxes.”

Perhaps the biggest downside of an FSA is the expiration of funds at the end of the plan year. The employer owns the account and participants are limited in how much they can contribute to it. 

To summarize the pros and cons of an FSA:

Example of how an FSA can save you on health-care expenses

An FSA reduces your taxable income by the amount you elect to contribute. For example, if your income is $70,000 and you elect to take the full $2,850 amount that is allowed by the IRS, you reduce your gross income to $67,150. Your employer will withhold taxes on $67,150 instead of $70,000. 

What this comes down to after taking the standard deduction:

$70,000 – $25,900 = $44,100 taxable income.

$67,150 – $25,900 = $41,250 taxable income.

This results in reduced federal income taxes as follows:

The taxes for $44,100 would be $4,881. 

The taxes for $41,250 would be $4,539. 

For saving $2,850 in a FSA, you’ll reduce your tax liability by $342. Perhaps more importantly, you have money set aside for medical expenses — both planned and unplanned. 

How to choose between an HSA and an FSA

Choosing between an HSA and an FSA may come down to what your employer offers. If you’re lucky enough to have the option to select one or the other, you’ll want to evaluate your individual situation. 

“If you are relatively healthy now and want to use your health care funds as long as possible, an HSA is a great idea,” says Claire Hunsaker, a chartered financial consultant and founder of the women’s online financial community, AskFlossie. “You can let the money grow for years, decades even, and only pull it out when you have medical expenses in retirement. At that point, the earnings might pay your expenses, leaving your contributions intact to continue growing.” 

On the other hand, some people prefer, and may even need, the predictability that having a PPO or HMO insurance plan offers alongside an FSA. Electing to go the route of an HSA means consumers would need to be on a high deductible health plan instead of a traditional insurance plan. 

“This decision comes down to your budget, your health, and your employment situation,” Hunsaker says.