Not too long ago, employers started offering High Deductible Health Plans (HDHPs) as coverage for their employees. These plans were designed to encourage employees to make better decisions about their healthcare. The idea was that employees would be more selective about the types of healthcare they elected to have over the course of the year, since they knew that they could not receive full insurance coverage until they met their high deductible. However, HDHPs found that people often needed help meeting these high deductibles, and so the Health Savings Account was born.
A Health Savings Account, or HSA, allows you to make pre-tax deposits every year, so you can set aside money for medical expenses not paid by your HDHP. With an HSA, you’ll pay lower federal income taxes and you can withdraw funds at any time to pay for health expenses such as medical care, vision and dental care, prescription drugs, and long-term care services and insurance. This includes your monthly premiums and any co-pays at doctor visits. (Find a full list of HSA-eligible expenses here.)
Please note that if you withdraw your HSA money for non-medical expenses, you will have to pay a penalty tax.
There is a yearly limit to what you and your employer can contribute into your HSA account. However, if you don’t use the money you put into your HSA, you can roll it over into the next year--and you can take it with you if you have to leave your job for any reason. The only catch with the latter is that in order to take the HSA with you, you must keep your HDHP through COBRA coverage continuation through your employer.
What is an FSA? Do You Need One?
Flexible Spending Accounts, on the other hand, only come as part of a benefits package through your employer; you do not have the option to purchase one on your own. Just as with an HSA, the money you deposit into an FSA comes out of your paycheck before taxes, and you can use those funds for the exact same medical expenses as you would an HSA.
Because an FSA is attached to your employer, there are a couple of catches. The money you put into an FSA is “pre-funded.” This means that even though what you put into it every year is taken out of your paycheck in regular, smaller increments as opposed to one giant lump sum, the full contribution that you selected during open enrollment is put into the actual account and is available for you to spend at the beginning of the year. If you end up leaving your job in the middle of the year, you’ll likely have to pay back any spent funds that haven’t yet been covered by your paycheck deductions. For example, let’s say you plan to deposit $50 a month into your FSA from your paycheck. You end up leaving your job in March, but by that point, you’ve already used $200 from your FSA. In that scenario, you would have to pay your employer back the $50 they essentially fronted you for those medical expenses before your April FSA deposit. You can’t take your FSA with you if you leave your job.
The other unfortunate catch to an FSA is that in most cases, you cannot roll over the money you don’t use into the next year. We recommend checking with your employer if there is a rollover option--and if there is, ask if it has a limit. Typically, the IRS limits the amount you can rollover in an FSA to $500.
You may not qualify for an FSA if you already have an HSA, unless the FSA is a “limited purpose” account. Someone in HR with your employer can give you guidance on this as well.
What should you budget for in your FSA? One example is an elective surgery. Let’s say you know you’re scheduling a total hip replacement surgery at some point in the year; you can allocate some funds into your FSA to cover any additional costs around that. You can also allocate funds into your FSA for daycare.
How Do You Choose Between an HSA and FSA?
So, which option is best for you? Generally, people who are younger and in good health with few prescriptions and preexisting conditions will be well covered with an HSA and high deductible health plan. Even though HDHPs can involve high out-of-pocket limits, the monthly premium is far cheaper, so if you don’t have many healthcare needs, they can still be a more cost-effective option for you.
If you or one of your dependents has high medical costs on a regular basis, due to age or any preexisting conditions, it is probably more cost-effective for you to sign up for a robust insurance plan at a higher monthly premium rather than an HDHP, which means an HSA won’t be an option for you. Even though an FSA has its share of catches, it will still help you save money and can be paired with any plan, as long as your employer offers it.