HSA or FSA?

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What is the difference, and which should you choose?

So what’s the difference between a HSA and FSA?

If you’re in the October/November time period at work, you’re probably searching for answers to this question because it’s open enrollment time! Your employer is giving you the options between these two accounts, but you’re having a hard time deciding which one to go with. I will try to go above and beyond the checklist that your employer provided to help you decide if you want the FSA or HSA.

FSA (Flexible Spending Account)

FSA stands for flexible spending account. If you see the term “health flexible spending account”, they mean FSA. So don’t confuse it with the HSA.

1. You don’t have to have a high deductible health plan (HDHP) to use a FSA. You pay a monthly premium for your insurance in exchange for a lower deductible.
2. You pick an amount each year up to the allowable limit that you want to have available for medical expenses ($2,750 for 2021).
3. That amount is then broken down to equal amounts to be taken from your paychecks. This lowers your taxable income (a pre-tax benefit).
4. Money can only be used for medical expenses. You don’t not pay tax on this money when it is used for an appropriate medical expense.
5. You have to use all the money (with the exception of a small amount you can rollover to the next year) within the year or you lose the extra.

Okay, so this is basically all the same info you’ll get from your employer. Here’s my take on them…

FSA’s are similar to a credit card. You get to pick the limit at the beginning of the year, and you get to use the money without having it saved up first. FSA’s can be useful if you know you have big expenses coming up during the year, like braces, but don’t have money saved for it yet.

Something you need to really understand is that if you don’t use up all that money during the year, you don’t get to keep it. Your employer makes sure they get they get this amount from you by taking equal payments from each paycheck, regardless of whether you use it all or not. For 2021, you are allowed to rollover $550, but otherwise, it’s a use it or lose it scenario.

HSA (Health Savings Account)

Health Savings Accounts (HSA’s) are an increasingly popular way to save for medical expenses. Here are the main points:

1. You must have a HDHP to be able to contribute to a HSA.
2. You pick an amount each year up to the allowable limit that you want to contribute to your account (for 2021, that limit will be $3,600 for an individual and $7,200 if you have a family plan). If you contribute more than the allowable amount, you have to withdraw it and pay taxes on it at tax time.
3. This amount is broken down in equal amounts to be taken from your paychecks. This lowers your taxable income (pre-tax benefit).
4. Money can only be used for medical expenses. You don’t pay tax on this money when it is used for an appropriate medical expense.
5. You can only spend as much as is available in your account.
6. You do NOT have to use all the money by the end of the year. This is like a regular savings account in that the money you put in is yours, you keep it, no matter what, even if you change employers!

Because it’s literally a savings account, you have the advantage of just stockpiling cash in this account. The money is yours, and it doesn’t go away if you don’t spend it all in one year. I’ve contributed the up to the max limit and rolled over thousands of dollars, unlike my example above with leftover money in your FSA.

Here’s my favorite part of HSA’s: they are a triple tax-advantaged account. Your money goes in pre-tax, withdrawals are tax-free (when used for legitimate medical purposes), and any gains on investments are also tax-free!

Gains on investments? Yes, you read that correctly! In case you didn’t know, most places allow you to invest your funds just like a regular brokerage account. If you have the option of being able to invest some of these savings (many employers offer this), this is really advantageous because it allows you to use the power of compounding to increase your money over time, and then you don’t have to pay tax on the gains when you withdraw funds for medical reasons!

If this option is available, take advantage! I advise keeping your deductible amount available in cash in the account, but invest any amount you save beyond that.

The pros and cons of the FSA and HSA

Let’s review the differences agan.

A FSA is like a credit card. Let’s say you decide to do the maximum limit, which is $2,750 for the upcoming year. You can spend $2,750 at the beginning of the year even though you have not contributed that amount yet. This might be helpful if you know you have a big medical expense coming up but money has been tight and you haven’t been able to set aside enough to pay for this. Having that credit card-like feature might be attractive to you.

The downside is if you spend that at the beginning of the year, you can’t spend more than that. You’ll have to use your own after-tax money.

An alternative downside would be if you DON’T spend it all- say, you’ll only use $1,450- you still are having money come out of your paychecks. Thankfully, you can rollover $550 of that. But that leaves $750 you have to spend, or you just lose it. You don’t get a refund, and your employer still has to keep taking money out of your paychecks even though you’re not using.

You could withdraw this money, but you’d have to come up with a $750 medical expense in order to do that. For myself, I couldn’t come up with $750 in medical expenses, usually. And if you just pulled it out, you’d pay tax plus a penalty because you didn’t pull it out for medical expenses. This isn’t a great scenario.

You get the credit limit at the beginning of the year and then pay for that with paycheck withdrawals each paycheck. That’s why you have to use it up every year, because you’re setting the amount you intend to spend at the beginning of the year.

You’ll notice that the FSA contribution limit is less than the HSA limit. If you max out your FSA, the amounts from your paycheck will be less than if you were maxing your HSA contributions. For some, this might be more attractive, but remember that the amount of pre-tax money you’re able to use is also less.

An HSA is more like a savings account, so you have to have money saved up to cover your medical expenses. Otherwise, you’re having to pay for things either with after-tax savings or a credit card, yikes! For those who find it harder to save up for these expenses, or have a hard time maxing out their HSA contributions because money is tight, this could be problematic.

Unlike FSA’s, HSA’s are triple tax-advantaged: money goes in pre-tax, your withdrawals are not taxed (when used for medical expenses), and investment gains are also tax free (when used for medical expenses).

So, back to which should you choose?

Of course, it’s always up to you, but I’m pro HSA, if you couldn’t tell. Let me run through the reasons again of why I choose this option:

1. The HSA has more tax advantages than the FSA. Period
2. You get to stockpile pre-tax money in this account to pay for higher cost medical expenses, like having a baby. With an FSA, you’re limited to that one low amount for a year, you never get to accumulate extra to pay for higher medical costs pre-tax. ,
3. With HSA’s, you don’t “use it or lose it”, and can take it with when you switch jobs.
4. The fact you can invest the excess savings and take advantage of the magic of compounding and GROW your money.
5. You don’t pay tax on the investment gains! It’s still not taxable when used for medical expenses!

So, I hope that helps clarify the differences in these two accounts and helps you think of it in terms of how it could affect your life. Have I convinced you to get an HSA, or do you want to stick with a FSA? Let me know what you think!