FSA vs HSA: Which health spending account is right for you?

Part of responsibly managing your medical expenses is understanding your savings and financing options. Two popular choices are Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs). Both are tax-advantaged health spending accounts designed to help individuals and companies save on healthcare expenses. But which one is right for you and your employees?

In this article, we’ll break down the differences and discuss the key features and benefits of FSAs and HSAs, so you can make the best choice for you or your employees.

What are FSAs and HSAs?

In simple terms, they're both tax-advantaged accounts that let you set aside money for qualifying healthcare expenses. These accounts can reduce taxable income, making them a great option for both employers and employees. But they differ in terms of eligibility, contribution limits, and flexibility. 

What is a Flexible Spending Account (FSA)?

A Flexible Spending Account (FSA) is an employer benefit that allows employees to set aside pre-tax dollars to cover qualified medical expenses like doctor visits, prescriptions, and over-the-counter drugs.

Key Features of an FSA:

• Pre-tax contributions: Employees contribute to an FSA on a pre-tax basis, lowering their taxable income.
• Employer-sponsored: FSAs are offered through an employer. Both the employee and the employer can contribute to the account.
• Use it or lose it: Typically, unused funds in an FSA don't roll over into the next year. However, some employers offer a grace period or allow a small portion of funds to roll over.
• Immediate availability: Employees have access to the full amount of their annual contributions at the start of the year, even if they haven’t fully contributed yet.

What is a Health Savings Account (HSA)?

A Health Savings Account (HSA) is a tax-advantaged savings account designed for people with a High Deductible Health Plan (HDHP). An HDHP is a type of health insurance plan with a higher deductible than traditional plans, but lower monthly premiums. The high deductible can make everyday health care needs quite costly, which is where an HSA can be helpful. HSAs allow both employees and employers to contribute pre-tax dollars to the account, and the funds can be used to cover qualified medical expenses.

Key features of an HSA:

• Triple tax advantage: Contributions are made pre-tax, growth is tax-free, and withdrawals for qualified expenses are also tax-free.
• Portability: The account belongs to the individual and is not tied to their employer. It follows them even if they change jobs.
• Rollover flexibility: Unlike FSAs, funds in an HSA roll over from year to year with no limit.
• Eligibility: To qualify for an HSA, individuals must be enrolled in a High Deductible Health Plan (HDHP).

Difference between FSA and HSA

While FSAs and HSAs are similar, they have some key differences, as seen below:

Pros and cons of FSAs and HSAs

Choosing between an FSA and an HSA depends on the individual healthcare needs and financial goals of you or your employees. There are advantages and disadvantages to each account. 

Advantages of Flexible Spending Accounts (FSA)

1. Immediate tax savings on eligible expenses
FSAs allow employees to contribute pre-tax dollars, reducing their taxable income and helping them save money on healthcare costs throughout the year.

2. Funds are available upfront

With an FSA, the entire amount of an employee's annual contribution is available on the first day of the plan year, even if they haven't fully contributed.

3. Ideal for short-term medical expenses

FSAs are a great option for people who anticipate frequent healthcare expenses throughout the year, like prescription medications or regular doctor visits.

Disadvantages of Flexible Spending Accounts (FSA)

1. "Use it or lose it" rule

FSAs come with a "use it or lose it" policy, meaning that if individuals don’t spend the money within the plan year, they risk forfeiting it.

2. Tied to the employer

FSAs are employer-sponsored, meaning individuals lose access to the account if they leave their job.

3. Limited to medical expenses and dependent care

While FSAs cover a wide range of qualified medical expenses, they are restricted to medical care and dependent care expenses. For example, FSAs can be used for prescription drugs, dental care, and contact lenses, but not for baby formula or personal hygiene products. 

Advantages of Health Savings Accounts (HSA)

1. Triple tax advantage

HSAs offer what's called a "triple tax advantage" which means employees can contribute pre-tax money, earn tax-free interest, and withdraw funds tax-free for eligible expenses.

2. Unused funds roll over

One of the biggest advantages of an HSA is that funds roll over from year to year, allowing employees to save up for larger medical costs.

3. Portable and flexible

HSAs are not tied to an employer, meaning employees can take their account with them if they switch jobs or retire.

Disadvantages of Health Savings Accounts (HSA)

1. Eligibility requirements

To qualify for an HSA, individuals need to be enrolled in a High Deductible Health Plan (HDHP), which can mean higher out-of-pocket medical expenses before reaching their deductible.

2. High upfront costs

With an HDHP, individuals pay more out-of-pocket for healthcare services until they meet their deductible, which can be a financial burden.

3. Contribution limits

HSA contribution limits are higher than FSAs, but there are still restrictions to how much individuals can save annually. 

Choosing between FSA and HSA: Which is best for your business?

Whether you’re a startup, small business, or enterprise company, deciding between offering an FSA or HSA to your employees should depend on these factors:

1. Employee health needs

If your employees tend to have regular healthcare expenses, an FSA may be a better fit. For those with higher deductibles and a focus on long-term savings, an HSA could be more beneficial.

2. Financial goals

Employees looking to save for future healthcare costs may prefer an HSA because of its rollover and investment potential. On the other hand, FSAs are better suited for short-term medical needs.

3. Eligibility

HSAs are only available to employees enrolled in an HDHP, while FSAs are more widely accessible.

4. Contribution limits

HSAs offer higher contribution limits than FSAs, allowing employees to save more.

5. Portability

If portability is a priority, an HSA is the better choice as it follows employees from job to job, while FSAs are tied to an employer.

6. Tax benefits

Both accounts offer tax advantages, but HSAs provide the additional benefit of tax-free growth on investments.

7. Risk of forfeiture

FSAs come with a “use it or lose it” rule, which can lead to forfeit of unused funds. HSAs, by contrast, allow funds to roll over indefinitely.

Automating FSA and HSA Management with Rippling

Managing FSAs and HSAs for a workforce, whether big or small, can be time-consuming and complicated. Rippling can simplify the process by automating the management of employee benefits, including health insurance, 401(k) accounts, COBRA compliance, and more. Rippling’s platform also integrates with payroll, making it easy to to adjust employee contributions and maintain accurate records.

Learn how Rippling can help streamline FSA and HSA management for your business.

Frequently Asked Questions

How do FSA & HSA work?

Both FSAs and HSAs are tax-advantaged accounts that allow people to save money on healthcare expenses. FSAs are employer-sponsored, while HSAs require enrollment in a High Deductible Health Plan (HDHP) and offer more flexibility and rollover options.

Can you offer both an FSA and an HSA?

Yes, it’s possible to offer both an FSA and an HSA, but they cannot be used for the same expenses. Usually, an individual would have an HSA for medical expenses and a limited-purpose FSA for dental or vision expenses.

Is a healthcare FSA worth it?

A healthcare FSA is worth it if you have predictable medical expenses throughout the year, as it allows you to save on taxes and access funds upfront for eligible expenses.

What are FSA-eligible expenses?

FSA-eligible expenses typically include medical, dental, and vision care costs, as well as prescriptions and some over-the-counter items.

What are HSA-eligible expenses?

HSA-eligible expenses are similar to FSA expenses, covering medical, dental, and vision care, but HSAs also allow for investment growth on unused funds, making them great for long-term savings.

This blog is based on information available to Rippling as of September 26, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.