HSA vs FSA for health costs

A health savings account and a health flexible spending account are the two ways the tax code lets you set money aside before tax to pay deductibles, copays, prescriptions, dental and vision bills. Employers often present them side by side during open enrollment, and the acronyms invite confusion. They are built on different principles. The HSA is a personal account that belongs to you and depends on the kind of health plan you carry. The FSA is an employer benefit that belongs to the plan, works with any health coverage, and runs on an annual clock.

Which one you can have is partly decided for you by your health plan and your employer. Where you have a real choice, the answer turns on how predictable your medical spending is, whether you are likely to change jobs, and whether you want the account to do anything beyond paying this year's bills.

The HSA: your account, on one condition

To contribute to a health savings account you must be covered by a high-deductible health plan as the tax code defines it, and by no other coverage that pays before the deductible, including a general-purpose FSA, a spouse's plan or Medicare. Within that condition the account is yours. Contributions come out before federal income tax and, when made through payroll, before payroll tax; the balance grows untaxed; withdrawals for qualified medical expenses are untaxed. Contributions are capped at an annual figure the IRS sets each year, higher for family coverage, with a catch-up allowance in later working life.

Nothing is forfeited. Money not spent stays in the account, can be invested once the balance clears the custodian's threshold, and follows you when you leave the employer or the plan. After the age at which the penalty on non-medical withdrawals ends, the account behaves like a traditional retirement account for any purpose and remains untaxed for medical purposes. An HSA can pay Medicare premiums and long-term care premiums within limits, and it can reimburse you years later for a bill you paid from pocket today if you kept the receipt.

Once you enrol in any part of Medicare you can no longer contribute, and because Part A enrollment can be backdated when you claim Social Security after sixty-five, the last months of contributions before that point need care. Spending from the account continues without restriction.

The FSA: the employer's plan, on an annual clock

A health flexible spending account is set up by an employer under its cafeteria plan. You elect an amount for the year, up to a cap the IRS sets, it is deducted from pay before income and payroll tax in equal instalments, and you can spend the entire elected amount from the first day of the year even though you have only paid in a fraction of it. If you leave the employer mid-year having spent more than you contributed, you generally keep the difference; the employer bears that risk, which is part of why the plan is theirs rather than yours.

The price of that arrangement is the use-it-or-lose-it rule. Amounts unspent at year end are forfeited to the plan unless the employer has adopted one of two permitted softenings: a short grace period into the new year, or a carryover of a limited amount. Not both, and not necessarily either. The account is not portable, does not earn or invest, and ends when employment does, subject to any continuation rights. A limited-purpose FSA, restricted to dental and vision, is the version that can sit beside an HSA without disqualifying it, and a dependent care FSA is a separate account for childcare that is often confused with the health version.

The mechanism that differs: ownership and time

Both accounts deliver the same tax result on a dollar spent on medicine this year. They differ on the dollar not spent. In an HSA it remains yours indefinitely; in an FSA it is at risk on a date. They differ on the dollar spent before it was contributed: the FSA advances it, the HSA does not. And they differ on who the account depends on: the HSA on your health plan's design, the FSA on your employer's willingness to offer it.

The high-deductible condition is the part people weigh wrongly. A high-deductible plan carries a lower premium and a larger deductible than a traditional plan, so the household takes on more of the first-dollar cost in exchange for the HSA's tax advantages and the premium saving. For a healthy household that can fund the deductible from savings, that trade is usually favourable and the HSA compounds it. For a household with a chronic condition and predictable heavy use, a traditional plan with an FSA can cost less in a year even before the tax comparison.

A worked year

Suppose a couple in Ogden is offered two plans at work. The traditional plan costs $600 a month in premium with a $1,000 deductible and allows an FSA election. The high-deductible plan costs $400 a month with a $3,500 deductible and allows an HSA, and the employer adds $750 a year to it. Say their combined marginal tax rate including payroll tax is 30 percent, and they expect roughly $2,000 of medical, dental and vision spending in the year.

On the traditional plan they pay $7,200 in premium, elect $2,000 into the FSA, spend it, and save about $600 in tax: a net cost near $8,600 for premium and care. On the high-deductible plan they pay $4,800 in premium, contribute $3,000 to the HSA and save about $900 in tax, receive the $750 from the employer, and pay the $2,000 of care from the account, leaving $1,750 in the HSA at year end that is theirs to invest or hold: a net cost near $5,900 with a growing balance. Now suppose instead the year brings a $12,000 surgery. The traditional plan's deductible and coinsurance might leave them $2,500 out of pocket; the high-deductible plan's might leave them $4,500, and the gap narrows sharply, though the premium saving and the employer contribution still favour the HSA. The figures are invented, and the comparison should be run with the actual plan documents, but the pattern holds: the HSA route wins clearly in ordinary years and roughly breaks even in bad ones, provided the household can fund the deductible.

Who each suits

• The HSA suits a household that can cover the high deductible from savings, expects moderate or unpredictable medical spending, may change employers, and wants to build a tax-advantaged balance for later medical costs including in retirement.
• The FSA suits someone whose plan does not qualify for an HSA, whose spending is predictable, such as orthodontics, a planned procedure or ongoing prescriptions, and who wants the full election available in January.
• A limited-purpose FSA alongside an HSA suits someone with known dental or vision spending who wants to preserve the HSA balance for investment.
• Neither suits someone who cannot estimate spending at all and has no savings; an FSA risks forfeiture and a high-deductible plan risks an unfunded deductible. For that household, a traditional plan and a modest FSA election is the conservative route.
• The HSA stops suiting anyone about to enrol in Medicare, who should time the last contributions and then keep the account to spend.

The decision rule

If your plan qualifies and you can fund the deductible, take the HSA, contribute at least what the employer matches and ideally the maximum, and pay small bills from pocket where you can so the balance grows. If your plan does not qualify, take the FSA and elect only what you are confident you will spend, checking whether the employer offers a grace period or a carryover. If you have both options through a couple's two employers, note that a spouse's general-purpose FSA disqualifies your HSA, so the couple should choose one structure together. Keep every receipt for either account; the accounts are self-reported and the substantiation burden is yours.

When the answer is to keep what you have

An HSA already funded should be kept whatever plan you move to; contributions stop if the new plan does not qualify, but the balance and its tax treatment continue. An FSA that has worked for years for predictable spending does not need to be abandoned for a high-deductible plan the household would find stressful. This is an area where the health plan choice leads and the account follows, and where the analysis is arithmetic rather than judgement. We run it with the plan documents for households in Arizona, Nevada, Utah and Idaho at open enrollment, and if the plan and account you have are the right pair for the year you expect, we say so.