Flexible Spending Accounts and Health Savings Accounts are two opportunities Americans may choose to set aside money from their paychecks to use for medical expenses. Set-aside means the money goes into an account for you to use later. Each account has its own benefits, and different rules for usage. Here is a description of similarities and differences between Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs).
The Biggest Similarity Between FSAs and HSAs
The most important commonality between the two accounts is that you are allowed to set aside the money before you pay income taxes on it. As long as that money is only used for "qualifying expenses" (see below) then you will never pay income tax on that money.
That pre-tax set aside can add up to big savings for you. Example: If you spend $500 on health-related expenses after you've paid income taxes, then you might have had to earn $650 to have that $500 to begin with (depending on what tax bracket you are in.) If you put that money into an HSA or FSA, meaning you didn't have to pay taxes on it, then you only have to earn $500 in order to have that $500 to spend. In effect, you worked fewer hours to earn that money, and your health-related cost was $150 less.
The Biggest Difference Between FSAs and HSAs
Note the first difference, which often gets mixed up when the two are compared. The FSA is a spending account. That indicates that you are expected to spend the money you have set aside within the year it is set aside. The HSA is a savings account, meaning, you may save that money until you need it, even if you don't need it until many years later.
An Overview of a Flexible Spending Account
A flexible spending account is a one-year set aside. Each month in that specific year, an amount of money you have pre-determined will be deducted from your paycheck and put into an account for your use during that same year. You may use that money for any "qualified expense" as determined by the Internal Revenue Service (IRS).
Qualified expenses may be medical, but they may also be day care (for children or elderly, dependent adults) related, too. The IRS keeps an updated list of FSA qualified medical expenses.
To use the money you have set aside, you submit the receipt for a qualifying expense to someone in your company who has been designated to handle those receipts. That person then submits your receipts to the institution handling your FSA and you are reimbursed that money from your own account. In recent years, some larger employers have begun to issue debit cards for direct access to your FSA so you won't have to go through the receipt-submission process.
The key to an FSA is that it is use-it or lose-it. The money you set aside in one year must be spent in that year, or it will be forfeited. That's why it is important to estimate very closely how much you think you will spend for qualifying expenses each year.
As is true for any government program, you'll want to be familiar with the rules for use of FSAs to be sure an FSA is a good choice for you.
An Overview of a Health Savings Account
A health savings account is a multi-year, maybe even a lifetime set aside account. Deposits to the account may come directly from your paycheck, your employer may make deposits to the account, or you may make deposits on your own. As described above, the money saved in an HSA is not income-taxed.
When the time comes that you have paid out-of-pocket for a qualified medical expense, you may reimburse yourself from your HSA. Unlike an FSA, only medical or health-related expenses qualify for reimbursement from your HSA. If you take the money out for any other reason, it will become subject to taxes and possible penalties.
The IRS maintains a list of medical expenses that qualify for an HSA. That list includes co-pays, deductibles, drug costs, durable medical goods like canes or eyeglasses.
The major benefit to an HSA is the fact that the money is always yours to keep or use. It does not go away at the end of the year. You might save that tax-free money in an HSA while you are in your 20s, and never use it until you are in your 60s - or even later.
While it would seem like such a savings account would be a great idea for everyone, not everyone is allowed to have an HSA. Only those who have a high-deductible health insurance plan may set up an HSA in order to take advantage of the tax benefit. The rules about how high that deductible must be, and how much can be saved vary from year to year.
Before you set up an HSA, you'll want to clearly understand how an HSA works, and how it is paired with a high-deductible health insurance plan, plus the rules and limits for saving and reimbursement.