HSA vs FSA: What You Need to Know to Save Money on Healthcare

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Today, many individuals are trying to figure out how to pay for various health-related services and products not covered by their health insurance plans. Often, high deductibles, copays, and other costs stand between a healthy lifestyle and financial reality.

Signed into law in 2003, Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) are federal programs designed to alleviate some of these problems, by improving affordability through tax relief.

For employers, offering one or both of these accounts can be an attractive benefit for employees. With smart planning and a good understanding of the differences between an HSA vs FSA, the savings can be substantial.

This blog will help you to better understand how HSAs and FSAs work, as well as some of their key differences so that you will be able to make the right decision between HSA vs FSA to best benefit your employees.   

What is HSA?

A Health Savings Account (HSA) is intended to help individuals to pay for or reimburse healthcare costs not covered by their insurance plans. It functions much like a personal savings account, with the added benefit of tax exemption as long as funds are used correctly.

HSAs are owned by employees and are portable, meaning that funds in an HSA can be carried over year to year. HSAs can also be retained following a job switch or exit from the workforce, and self-employed individuals are able to open an HSA.

HSA Eligibility

An employee is only eligible for an HSA if their health insurance plan is considered to be a high deductible health plan, or HDHP, defined by high annual deductibles and low monthly premiums. Specifically, their health insurance must have an annual deductible of at least $1400 for an individual plan or $2800 for family plans.

Additionally, the employee’s healthcare costs must fall below certain maximum out-of-pocket expense requirements, $6900 for an individual or $13800 for a family.  You must be eligible on December 1st before the beginning of the year, in accordance with the last-month rule, and remain eligible until December 31st of the following year in order to avoid penalties and to continue contributing.

HSA Contributions and Withdrawals

Contributions to an HSA can be made by employers, employees, and their family members, all of whom can contribute to the HSA as they wish throughout the year. For employees, contributions are typically made at regular pay period intervals. These employee HSA contributions are often made through wage withholding, and funds are available as soon as they are remitted by their employer.

There are HSA contribution limits restricting the amount of money employees can deposit into their HSA. Employees under the age of 55 can contribute $3600 if their account is set up for the individual and $7200 for families. Over the age of 55, employees can contribute $4600 for an individual account and $8200 for a family account.

For HSAs, these limits are cumulative between all contributors: employer contributions plus employee contributions cannot exceed the contribution limit. Also, keep in mind that these limits apply to 2021 and are subject to change annually.

To execute an HSA withdrawal, employees can opt to have a debit card for the account, or they may choose to reimburse payments. Of course, it is important to keep in mind that HSAs are only tax-exempt as long as they are used to pay for the specified list of eligible expenses. Otherwise, funds are subject to an additional 20% penalty when removed from the account.

Benefits of a Health Savings Account

For Employees

HSA accounts can be used to pay for a variety of health-related expenses, including but not limited to deductibles, copays, most prescriptions, insulin, dental care, and some medical equipment. Additionally, the CARES (Coronavirus Aid, Relief, and Economic Security) Act, recently passed by Congress in 2020 in response to the Coronavirus Pandemic, enables individuals to use FSA funds for over the counter drugs and menstrual products with or without a doctor’s prescription. A more exhaustive list of eligible healthcare expenses can be found in the Internal Revenue Service’s Health Savings Account Manual

HSAs help individuals accumulate funds for these procedures by offering tax relief. Monetary contributions are made pre-tax, and thus exempt from income tax. Additionally, withdrawals from an HSA are not subject to any tax.

These features, coupled with the fact that HSAs retain their balance year to year and gain interest mean that well-managed accounts can potentially save owners thousands in taxes over many years of contributions.

For Employers

Just as there are some huge potential benefits for employees using an HSA, the same goes for employers who elect to offer them.

First and foremost, an HSA is an attractive offer to many employees or potential employees. Almost anyone with health insurance can open an account, and some individuals may stand to gain significant benefits from using an HSA. The potential employee savings typically outweigh any costs to the employer, which primarily include the employer contributions into employee accounts. These contributions are optional but many companies which offer HSAs take advantage of this option, as it can be a great additional incentive for employees. Additionally, the pre-tax nature of HSA contributions means that employers are not liable for what would otherwise have been regularly taxed income.

HSA vs FSA Account

What is FSA?

A Flexible Spending Account (FSA) is intended to help employees pay for out of pocket healthcare costs, but with no high deductible requirement like HSAs.

There are two primary types of FSAs: Health FSAs and Dependent FSAs, which are designed for those intending to pay for recurring medical expenses and dependent care respectively. Both accounts function somewhat like a personal savings account, and FSA withdrawals are tax-free as long as they are used for specific health-related costs.

Unlike an HSA, an FSA is always owned by the employer, and funds are not portable, meaning that funds in an FSA do not carry over year-to-year. FSAs cannot be retained after a job switch or exit from the workforce, with a few exceptions such as the onset of a disability.

Benefits of a Flexible Spending Account

For Employees

It is important to recognize the differences between Health FSAs vs Dependent FSAs when analyzing their benefits, as each has its own set of eligible expenses.

An FSA health care account can be used to pay for a variety of health-related expenses, including but not limited to deductibles, copays, certain prescriptions, insulin, dental care, and some medical equipment. Additionally, the CARES (Coronavirus Aid, Relief, and Economic Security) Act, enables individuals to use Health FSA accounts for over-the-counter drugs and menstrual products with or without a doctor’s prescription.

A more exhaustive list of the eligible expenses for a Health FSA account can be found in the Internal Revenue Service’s Flexible Spending Account manual.

Dependent FSAs can be used to pay for daycare, school, summer camps, elder care, and other varieties of care which last for at least eight hours per day. To be eligible for a dependent FSA, the dependent in question must be less than 13 years of age or otherwise meet IRS qualifications for an older dependent.

Both types of FSAs typically help individuals to pay for recurring expenses by providing tax relief. Like an HSA, contributions made to an FSA account are made pre-tax, meaning that income tax is not applied. There are no fees or taxes associated with withdrawing money either.

Despite these similarities to an HSA, the other requirements regarding the function of FSAs mean that they serve a very different purpose. Rather than having the ability to accumulate funds to be used for health-related expenses down the road, the annual renewals and more restricted nature of an FSA account mean that funds are best used for only expenses which the employee during the open-enrollment period can reasonably predict will occur over the next year. Therefore, FSAs are best used for recurring payments or for one-time procedures or expenses that are already scheduled.

For Employers

Just as there are some huge potential benefits for employees using an FSA, the same goes for employers who elect to offer them.

First and foremost, an FSA account is an attractive offer to many employees or potential employees. Almost anyone with health insurance can open an account, and some individuals may stand to gain significant benefits from using an FSA. These benefits provided by FSAs come at little cost to the employer, other than optional contributions into employee accounts.

Additionally, the pre-tax nature of FSA contributions means that employers are not liable for what would otherwise have been regularly taxed income.

FSA and Opening an Account

The eligibility requirements for an FSA are somewhat different than for an HSA. Having a high deductible insurance plan is not part of the requirements and accounts can only be opened by employees.

Generally, almost anyone with health insurance is employed is eligible for an FSA, with the one major exception being self-employed individuals who are ineligible. You must be eligible on December 1st before the beginning of the year, in accordance with the last-month rule, and remain eligible until December 31st of the following year in order to avoid penalties and to continue contributing.

HSA vs FSA Contribution

FSA Contributions and Withdrawals

Both employees and employers can contribute to FSAs. When employees contribute, they choose how much they want to put into their FSA account during a designated annual open enrollment period. The full value of these funds is immediately available, although employees will not be expected to provide the full sum upfront. The expectation is that employees will pay for their FSA account periodically throughout the year: think of it as interest-free debt.

If an employee leaves during the year and the cost of their FSA withdrawals up to that point are greater than the amount of their contributions, they are expected to continue contributing to their FSA until the expenses are paid off. On the other hand, if the funds contributed exceed healthcare costs, then the employer retains the full value of the account.

Typically, employees will not be able to change the amount contributed to their FSA outside of the open enrollment period. However, exceptions are made for approved claims of a life-changing event that cannot be covered by the previously specified contribution. These life-changing events primarily related to family matters, such as a divorce, marriage, birth, or death which would have been unforeseeable to the account holder when planning.

The Health FSA contribution limit is $2750, and Dependent FSA is $5000. Unlike an HSA, there is no distinction between individual and family limits or between age brackets. The limit is the same for any employee who opens an FSA.

FSA withdrawals are made using a specially designated debit card or through reimbursement claims describing the healthcare expense in question. Unlike HSAs, which allow for the withdrawal of funds for non-medical expenses with a 20% penalty, FSA funds cannot be withdrawn for anything but approved medical expenses.

FSA Rollover Exceptions

Typically, FSAs are designed so that roll over year to year is prohibited, and leftover funds are ceded to the employer. However, the IRS has provided two ways for employers to set up their FSA programs so that employees have some additional flexibility:

Employers may choose to allow for an FSA grace period at the beginning of the year, during which employees have the opportunity to use up their remaining funds. This period spans 2.5 months and lasts from January 1 through March 15.

Employers may also permit employees to roll over $500 in funds from one year to the next, which are immediately available for use. These rolled over funds do not count towards the maximum contribution for the following year.

HSA vs FSA: The Summary

 

   

   HSA vs FSA                                                                                       

Dependent Flexible Spending Account Health Flexible Spending Account Health Savings Account
Who is eligible?                                       Almost all employees, except for the self-employed Almost all employees, except for the self-employed Only individuals enrolled in a high deductible health plan (HDHP)
Are there
deposit
limits?
Yes, $2750 Yes, $5000 per household Yes, $3550 for individuals, $7100 for families; over the age of 55, each limit increases by $1000
Who owns the account? Employer Employer Employee
Is the account tax-exempt? Yes Yes Yes
Does interest accrue? No No Yes, but amount varies by HSA bank
Who can contribute?   Employees, employers, or family member Employees, employers, or family member Employees or employers
Is the account portable? No, the remaining account balance is forfeited to the employer following a change in employment. No, the remaining account balance is forfeited to the employer following a change in employment. Yes, the account balance can stay with the employee following a change in employment.
Is there rollover? Not typically, although employers can opt to allow some flexibility through a grace period or $500 rollover. Not typically, although employers can opt to allow some flexibility through a grace period or $500 rollover. Yes, any remaining funds are retained at the end of the year.
What can I use the account for? Qualifying Medical Expenses. It is impossible for FSA funds to be used for other expenses. Qualifying Dependent Care Expenses. It is impossible for FSA funds to be used for other expenses. Qualifying Medical Expenses. HSA funds can be used for non-medical income with a 20 per cent penalty.
When can funds be accessed? Money can be accessed before it is paid in Money can be accessed before it is paid in. Only funds paid in can be accessed.
When do I contribute?   During open enrollment, with the exception of after some major life events During open enrollment, with the exception of after some major life events Whenever; typically during regular pay periods

HSA vs FSA: What Should I Offer as an Employer?

With the state of the world, it is likely that more employees will be interested in HSA vs FSA. According to a March 2020 survey conducted by Devenir, $65.9 billion in funds is held in 28 million HSAs nationally. High deductibles are very common among health insurance plans, so many employees will likely be eligible.

In truth, most eligible individuals stand to gain significantly more from an HSA than an FSA too. Employee ownership, portability, rollover, higher contribution limits, and interest accumulation make it possible for HSAs to function as more of a long-term investment. These are aimed at paying for future healthcare expenses, a function which FSAs simply do not match. 

That being said, when maintained properly, both Health and Dependent FSAs can be just as beneficial to individual employees. This is when they’re faced with immediate and recurring expenses which can be easily predicted at the beginning of the year. In addition, many employers elect to offer FSAs because they feel that it is necessary to ensure that their employees who have to look after their children or other dependents are able to do so and to continue working, without having to sacrifice one or the other.

Ultimately, it is up to each employer to weigh the benefits and choose the best course of action for their individual situation to incase of HSA vs FSA. Many employers offer both HSAs and FSAs in employment contracts, but keep in mind this is not always compatible with all health insurance plans.

Employee input is key. When in doubt, ask which account your employees are most interested in opening.  Make your HSA vs FSA decision using their input.

Choosing the right plan, whether that’s HSA, FSA, or both, can bring substantial benefits to both employers and employees.