Health savings accounts vs. flexible spending accounts

With medical costs rising at twice the general rate of inflation. There are tax-advantaged tools that can help you save to meet these expenses, but it is important to understand the nature of those tools to get the best use out of them.

Two popular savings vehicles are flexible spending accounts (FSAs) and health savings accounts (HSAs). While they seem similar on the surface, they have some vital differences that affect how they should be used and invested.

What is an FSA?

An FSA is an employer-sponsored benefit plan, meaning that their availability depends on whether or not your employer offers one. You can contribute up to $2,650 per year to an FSA. The money can be contributed directly from your paycheck before taxes, or you can deduct the contribution amount on your income tax return if you fund the account with after-tax money. The important point is that as long as you use the money for legitimate medical expenses, which includes health care services, prescription drugs, and insulin, the money you put into an FSA is never subject to income tax.

The catch is that FSAs operate on a use-it-or-lose it principle. If you don't use the money you put into an FSA during the plan year, it will be forfeited. At most, some plans allow for a maximum of $500 to be carried forward for use during the subsequent plan year, but this is subject to the rules of your employer's specific plan.

The bottom line is that because the money in an FSA must be used in the near-term, you should limit what you put into an FSA to an amount you are pretty certain you will have to pay in medical expenses over the coming year.

What is an HSA?

Like an FSA, an HSA is an employer-sponsored benefit plan, but its usage is limited to people who participate in a high-deductible health plan (HDHP). An HDHP is health insurance with an annual deductible of between $1,300 and $6,550 for individuals, or $2,600 and $13,100 for family coverage.

As with an FSA, contributions to an HSA are tax exempt, but the important difference is that you do not have to use the money in an HSA within any specific time limit. This means you can accumulate money in an HSA indefinitely. Both your contributions to the HSA and any investment earnings on that money are tax-exempt as long as the money is ultimately used for legitimate medical expenses.

Not only can HSA contributions accumulate in the account over time, but they are subject to higher limits than FSA contributions. For 2018, you can contribute up to $3,450 if you have individual coverage in an HDHP, and up to $6,900 if you have family coverage. If you are aged 55 or over you can add another $1,000 to those limits.

What is the difference between an HSA and an FSA?

The following table summarizes the distinctive features of HSAs and FSAs:




Annual contribution limit

$3,450 for individuals, $6,900 for family coverage. People aged 55 and over can contribute an additional $1,000.


Eligibility for participation

Employment at a sponsoring firm and participation in a high-deductible health plan.

Employment at a sponsoring firm.

Uses for funds

Medical expenses, including prescriptions.

Medical expenses, including prescriptions.

Tax benefit

Contributed amounts are excluded from income for tax purposes. Spending from the account is not taxed as long as the money is used for qualified medical expenses.

Contributed amounts are excluded from income for tax purposes. Spending from the account is not taxed as long as the money is used for qualified medical expenses.

Carryover of funds

Money in the account can be carried over indefinitely, so account balances can accumulate over time.

At most, $500 can be carried forward for use during the following plan year.

When to use an HSA or an FSA

So if your employer offers both, how do you choose between an FSA and an HSA?

One factor is whether or not you regularly need health care beyond normal check-ups. If so, then an FSA might be the right choice for you. This would allow you to participate in a health insurance plan with a lower deductible, and your expectation of having health care expenses over the coming year means that the money is likely to be used up within the time limit.

In contrast, if you have no particular reason to expect major health care expenses over the next year, an HSA might make more sense. You can better afford to participate in a HDHP if you don't expect to have much in the way of health care expenses, and the higher deductible should allow you to pay lower premiums. Because you can carryover money in an HSA indefinitely, you can enjoy the tax advantage of contributing money to it without worrying about when you have to use it.

Investment implications

The fundamental difference in how FSAs and HSAs are designed to be used also dictates a difference in investment approach.

The use-it-or-lose it nature of an FSA means that the money should be kept liquid. This means investing it in a deposit account or cash-equivalent type of fund. In contrast, the ability to carry money over in an HSA means that some portion of your HSA can be put into long-term growth investments such as stocks.

In essence, you can think of an HSA as being available both to fund any immediate medical expenses that arise and as a way of augmenting your retirement savings. Since health care is an especially large expense in retirement, HSAs can be a good vehicle for accumulating money tax-free for future use. In fact, unlike money in a 401k plan, money in a HSA plan isn't even taxed when you eventually access it as long as you use it for medical expenses.

So, enough money to cover your annual health insurance deductible should be kept liquid within your HSA. Then, balances you accumulate beyond that can be invested in growth instruments to help meet medical expenses in the future.

While an FSA is a good vehicle for saving money to meet short-term medical expenses, an HSA has the added dimension of allowing you to accumulate and invest money to meet long-term health care needs.

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