HSA vs. FSA: Which Medical Spending Account is Right for Me?

The end of the year is approaching, which means it’s time to start making many important financial decisions for 2024. This will likely include evaluating benefits you receive from your employer, and there’s one perk that many individuals overlook: tax-advantaged medical spending accounts.

While not all employers offer flexible spending accounts (FSAs) or health savings accounts (HSAs), if yours does, it’s worth considering. Start by keeping an eye out for these acronyms during your open enrollment period. If you don’t hear your employer mention an FSA or HSA, ask about them to ensure you’re not missing out on an opportunity.

Let’s take a closer look at the benefits of FSAs and HSAs and the differences between each.

What is an FSA?

An FSA is an account you fund with pre-tax dollars, which you can use to pay for certain out-of-pocket medical and dental costs for you, your spouse, and your dependents, if applicable. Eligible expenses include:

  • Deductibles and copayments
  • Prescriptions and over-the-counter medicines with a doctor’s prescription
  • Medical equipment (e.g., crutches, bandages, and diagnostic devices)

Note that insurance payments are not eligible expenses. Your employer may contribute to your FSA, but they don’t have to.

What are the FSA annual contribution limits?

According to Mercer, the health care FSA maximum annual contribution limit is projected to increase from $3,050 to $3,200 in 2024. If you are married, your spouse can contribute up to the limit in an FSA from their own employer.

What are the advantages of an FSA?

A notable benefit of FSAs is the entire annual amount is available to you on day one of your enrollment based on how much you decide to contribute. For example, if you want to fund $3,000, you would contribute $250 per month, but the whole $3,000 would be available upfront.

If you opt for an FSA, it’s important to fund only as much as you think you’ll need during the year to avoid losing money.

What’s the downside?

The main disadvantage of an FSA is that you’ll typically lose any funds you don’t use by the end of the year. However, some employers provide a grace period of up to two and a half additional months to spend it OR roll over up to a certain amount into the following year ($640 in 2024).

Note that your employer is not required to offer a grace period or rollover. If they do, they can only provide one.

What is an HSA?

Like an FSA, an HSA is funded with pre-tax dollars and can be used to pay for your deductible and out-of-pocket medical expenses that don’t count toward your deductible, such as:

  • Copays
  • Prescriptions
  • Dental care
  • Contacts and glasses
  • Medical supplies
  • X-rays

…among many others!

However, HSAs are only available to you if you:

  • Enroll in a qualified high-deductible health plan (HDHP)
  • Have no other medical coverage
  • Are not enrolled in Medicare
  • Can’t be claimed as a dependent on someone else’s tax return

Also, like an FSA, your employer can make contributions—and 75% of them choose to. But if your employer doesn’t offer an HSA and you’re enrolled in an eligible plan, you can open your own.

What are the HSA annual contribution limits?

In May, the IRS announced that the 2024 HSA contribution limits will be increased to $4,150 for self-only coverage and $8,300 for family coverage. If you’re 55 or older, you can contribute an extra $1,000 per year as a catch-up contribution.

What are the advantages of an HSA?

When it comes to tax advantages, HSAs are a triple threat because:

  • HSA contributions lower your taxable income
  • The funds aren’t taxed while in the account
  • You won’t owe taxes on the money when you withdraw it as long as you use it for eligible medical costs

Another highlight is that you don’t have to use your HSA funds within a year. You can carry the money forward until you want or need to use it. You may even be able to invest your HSA balance to grow the money tax-free, saving significantly for your health care costs in retirement.

While your employer would technically own your FSA, you would own your HSA. If you change jobs, you can keep all the money and transfer it into a new account or an employer-sponsored HSA at your new company.

And once you reach age 65, you can use your HSA funds for non-qualified medical expenses without penalty. Just beware that you’ll have to pay income tax on it, like you would with withdrawals from a 401(k) or IRA. Before you turn 65, there is a 20% penalty plus applicable taxes on withdrawals used for ineligible health costs.

What’s the downside?

The key disadvantage of an HSA is that you must have an HDHP, which typically comes with lower monthly premiums. This means you’ll need the means to cover high deductibles and fund your HSA either through payroll deductions or directly.

Leverage a Tax-advantaged Medical Spending Account

So, does your employer offer an HSA or FSA? Ask them for the details and find out if you can only invest a portion or the maximum contribution limit. HSAs specifically provide significant tax benefits and future medical cost savings to eligible individuals.

Are you curious about maximizing your HSA as part of your retirement strategy? Contact a Carlson wealth advisor today to learn how we can help!

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