Flexible spending accounts and health care savings accounts are both tax-advantaged accounts that can be used to offset medical expenses, but they have some key differences. An HSA is used for more long-term savings, while an FSA can be used regardless of what type of health insurance plan you have. These accounts cannot be used together by the same person.
A flexible spending account is an employee benefit provided directly from your employer. It is a type of Section 125 "cafeteria" benefit, which reduces your taxable compensation in exchange for a benefit you receive. With an FSA, you put aside money each week before taxes to pay medical bills. This means your employer subtracts that cash from your paycheck and calculates the payroll taxes on the amount that remains after the contribution to your FSA. The result is that you save in taxes. Your employer saves as well, because it is not paying its portion of the Social Security taxes on your FSA contribution.
A health savings account is similar to an FSA, because your HSA contributions are also made before taxes. However to contribute to an HSA, you must be covered by a high-deductible health plan. An FSA does not have this requirement. In addition, you can potentially contribute a higher amount to an HSA each year, because your FSA contributions are limited to $2,500 a year, or a lower amount if your employer requires that. HSA yearly contributions can be as high as $3,250 for individual coverage, or $6,450 for family health expenses.
You are forbidden from contributing to an FSA and an HSA at the same time. Because both of these plans result in tax savings, the U.S. government is concerned that some people could take advantage of both plans to increase their tax savings over what is otherwise allowed.
If you have both plans available to you, an HSA is generally a better deal than an FSA -- as long as you are comfortable with also having a high-deductible health plan. An FSA is a use-it-or-lose-it proposition. Any money you contribute to the plan and do not use by the end of the plan year, you will forfeit to your employer. An HSA does not have this provision, and the money continues to grow tax-free. You can use the cash in your HSA for medical expenses at any time, without taxes or penalties. At age 65, an HSA becomes like a regular IRA account, and you can use the money for any purpose without penalty. You will owe income taxes on HSA withdrawals at age 65 unless the money is used for medical purposes. If you take the money out when you are younger, for any purpose other than medical expenses, you will pay a 20 percent penalty in addition to any income taxes due.
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