How to decide whether an HSA or FSA is right for you

A prescription co-pay here. A contact lens order there. And of course, the bandaids, cold medication, and antiseptic spray that constantly seem to need to be resupplied. No matter how healthy your family may be and how much your medical insurance may cover, most people are concerned about the best way to offset the cost of medical expenses. Even if you’re not nearing retirement yet, it’s still surprising how quickly copays for annual exams, wellness visits for your kids, and unforeseen emergencies can add up. Even if you have a well-padded emergency fund, dealing with an unexpected hospital bill could sink you by several thousand dollars – yikes!

Using a workplace savings account can help you prepare ahead of time for the smaller expenses you know you’ll incur throughout the year, and the bigger expenses you don’t see coming yet. Not only that, but because these accounts are funded with pre-tax dollars, they can help reduce your taxable income. Some employers offer a Flexible Spending Account (FSA) and/or a Health Savings Account (HSA). They both have their own unique sets of pros and cons – and different families can benefit from using them in different situations.

What are HSAs and FSAs used for?

Both the FSA and the HSA can be used for health-related expenses. Many people are surprised at what qualifies as “health-related.” An HSA is a little bit more rigid than an FSA, because an FSA can either be an account geared toward medical expenses, commuting or transit costs, or it can be an account geared toward Dependent Care (DCFSA), which is intended to help cover the cost of dependent care throughout the year.

Here are examples of expenses that qualify under an HSA :

Copays on doctor visits, exams, and prescriptions
Medical supplies like band-aids, first aid kits, or over the counter medicine
Large medical bills like those incurred during pregnancy, surgery, or other big procedures
Hearing aids
Psychological counseling
Chiropractic services
Family planning supplies
Breast pumps
Glasses (and contacts)
Physical therapy
Some programs intended to help you quit smoking, drinking, or using drugs

FSAs essentially cover the same expenses. A DCFSA covers:

Childcare while you’re at work
Summer camps or daycare during the summer months while you’re at work
Before or after school programs
Adult daycare (if you have an adult dependent)

If you spend from the accounts outside of these parameters, you’ll have to report the expense on your taxes and pay income tax. Additionally, if you’re under age 65, you will also pay a 20% penalty. This is because both FSAs and HSAs are tax-advantaged accounts. They are funded with pre-tax dollars, which has the potential to significantly lower your taxable income while still helping you save for future medical (or dependent care) expenses. Because of this, you’re forced to stay inside the boundaries of how you can spend the money in your accounts.

Most people enroll in an HSA or an FSA through their employer. There are a few additional rules here to keep in mind.

First and foremost, an HSA can only be opened if you are enrolled in a High Deductible Healthcare Plan (HDHP) insurance policy. If you have HDHP insurance and choose to open an HSA, that HSA belongs to you – not your employer.

FSAs, on the other hand, are typically employer-owned, which means you might not get to take the money with you if you separate from your employer.

Finally, it’s important to remember the key difference between your HSA and your FSA: your HSA’s funds rollover year-to-year because you own the account. Funds in your FSA often expire at the end of the calendar year, or your employer might limit how much you can carry over into the following year.

Benefits of an HSA

HSAs are fantastic savings vehicles for those who have HDHP health insurance and are looking to save for the long-term. Many people use HSAs as part of their retirement planning because the funds in the account never expire, and you can often invest them to increase their growth potential if you don’t need them with any sense of immediacy. So, as you move through retirement and your medical expenses potentially rise, you’ll have a significant nest egg earmarked for health-related expenses as you age.

HSAs currently have an annual contribution limit of $3,450 for individuals (or married people filing separately) and $6,900 for married couples filing jointly. A couple can save up to $6,900 for future family medical expenses (including your own future medical expenses in retirement) over the course of the year, and lower your taxable income by the same amount, which may be helpful for high earners who can afford to maximize their contributions to the account.

The final benefit to HSAs is that you get to take the money with you when you leave an organization, which often isn’t the case for an FSA account.

Benefits of an FSA

An FSA account is owned by your employer, not you. This means that you could potentially lose the funds if you leave your job, and your employer gets to dictate the rules for how they handle that account. (If you’re laid off, you may be able to continue to access the funds if you’re eligible for COBRA, but the specifics vary from company to company and it’s worth checking with your HR department)

Most employers approach the FSA with a “use it or lose it” mindset. In short, if you haven’t used all of the money in your account by the end of the year, it’s reabsorbed back into the company and you can’t get it back. Some companies have put in place features to help prevent this from happening. For example, you may have a certain number of days into each new year to use leftover funds in your account, or they may allow you to keep a minimal amount in the account from year-to-year.

The current annual contribution limit for FSAs is $2,650.

The DCFSA is a little bit different. An individual (or married person filing separately) can contribute $2,500 to a DCFSA for dependent care expenses. A married couple filing jointly can contribute $5,000 annually.

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Which option is the best for you?

If your employer offers FSA and HSA options, it makes sense to consider them and take advantage of pre-tax savings. But which one is the best option? That depends on a host of factors, including your dependent care and health-related expenses in the previous year and your current medical insurance coverage. Since you lose the funds in an FSA at the end of each year, an FSA may be a good option if you anticipate annual, eligible expenses. In addition, the ability to open both a health-focused FSA and a DCFSA makes it possible to save for both dependent care costs and medical expenses with pre-tax income. Of course, if you choose to go the FSA route, you’ll need to budget carefully to ensure that you’re not over-saving and potentially risking losing your money.

Meanwhile, because you’re able to save more in an HSA over the course of many years, you can use it as a long-term savings tool for big medical expenses like having a baby, orthodontic treatment, or another pricey medical procedure you anticipate in your family’s horizon — or as a way to save for potential medical costs in retirement. An HSA may be an option to consider if you’re job searching or aren’t necessarily sure you’ll be at your current company for the calendar year.

Can you have both an HSA and healthcare FSA open simultaneously? Usually, no, unless it’s a limited purpose FSA which specifically limits your spending to qualified dental and vision expenses for you, your spouse and your dependents which is why it can be helpful to view them as two separate accounts with individual goals.

Both the FSA and the HSA have their pros and cons, and they can each be used for different purposes as part of your financial plan. As with most money-related questions, knowing your reason behind using these tools can help you to guide your decision about which option is best for you and your family.

Mary Beth Storjohann, CFP® and Founder of Workable Wealth, is an author, financial planner and accountability partner working to help clients in their 20s-40s across the country make smart, educated choices with their money. Her recent accolades include the “Top 40 Under 40” by Investment News, “10 young Advisors to Watch” by Financial Advisor Magazine, and “10 of the Best Personal Finance Experts on Twitter.” She frequently appears on NBC as a financial expert and her expertise has been featured in The Wall Street Journal, CNBC, Forbes and more. Opinions are her own.

Haven Life Insurance Agency offers this as educational information. Haven Life does not offer investment or tax advice and encourages you to seek advice from your own legal counsel, investment advisor, or tax professional.