There is a lot of confusion around the difference between an HSA and a FSA. HSA stands for Health Savings Account. FSA stands for Flexible Spending Account, or sometimes, Flexible Spending Arrangement. Both types of medical savings accounts are tax-advantaged ways to save and pay for various medical expenses, but there are some very big differences.
These accounts are very important for tax planning because otherwise, there is a very high threshold before you can deduct any medical expenses you might have. For many people, an HSA will be better than a Flexible Spending Account, but only if your health insurance plan qualifies.
Flexible Spending Account or FSA
The FSA has been around longer, and so most people are more familiar with it. A flexible spending account is a benefit offered by your employer. You defer a certain amount of your paycheck into the FSA. Any funds contributed to an FSA are pre-tax contributions, just like a 401(k) contribution, which means you not only don’t pay taxes on that money, it doesn’t count as income for things like IRA contribution thresholds, or the child tax credit, or deducting student loan interest. That makes these contributions a very powerful tax management tool for people with higher incomes.
You can spend the money in your FSA on most medical expenses, including copays or deductibles, but not on the health insurance premiums themselves. (Your employer may offer a different benefit that allows you to pay for your health insurance premiums with pretax dollars.) Typically, you submit a form and receipts to whoever runs your FSA plan and they reimburse your for whatever expenses you may have.
One of the biggest limitations of a Flexible Spending Account, is that you must spend all of the money contributed to an FSA during a single year. Your employer may (but is not required to) offer an extra 2 1/2 month grace period, or let you carry over $500 to the next year, but not both. So, you need to carefully plan how much you want to contribute. You an contribute up to $2,550 per year, per employer into a Flexible Spending Account, or FSA.
Health Savings Account or HSA
A Health Savings Account, or HSA works a little differently. First, you have to qualify to open a HSA. The main qualification is that you have to have a High-Deductible Health Plan, or HDHP. That is, your insurance plan must be one that has a higher deductible than a “typical” plan as defined by the IRS. For 2016, the minimum annual deductible for yourself (the person who qualifies for the insurance) is $1,300. The minimum deducible for family members covered by the same plan is $2,600.
You open an HSA account on your own, although your employer may point you in the direction of an affiliated custodian. You own the money in the account, and you can take it with you, even if you leave your job. Also, the money in the account does not have to be spent in a single year. In fact, the whole point of an HSA is to build up money in the account to pay for your medical expenses, whenever they may occur.
Unlike a FSA, you can invest your FSA account funds in order to grow them over time. Obviously, this works best when you don’t have a lot of on-going medical expenses. In other words, if you are young and healthy and want to plan ahead, this is a great way to put aside some money for future medical expenses.
The maximum HSA contribution in 2016 is $3,350 if you have self-only coverage and up to $6,650 if you have family coverage. If you and your spouse both have qualifying coverage, then each spouse needs to have separate HSA account.