Health Savings Account & Flexible Spending Account

Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) are effective ways to help ease the burden of certain expenses. 

Because these accounts are often offered during benefits enrollment, it can be easy to mix up what each is used for and how they can affect your taxes. Read on as we define the terms, as well as uncover the tax advantages and differences between HSAs and FSAs.

What is an HSA account?

If you’re wondering, “What is an HSA account?” or “How does an HSA work?” let us explain. An HSA account or HSA plan is a savings account used to pay out-of-pocket medical expenses not covered by insurance. Out-of-pocket medical expenses examples are doctor visits, prescriptions, over-the-counter medicine, lab tests, and hospital stays.

You shouldn’t use HSA funds for some other purpose beyond health care expenses. If you do, the distribution is taxed at ordinary rates with a 20% penalty by the Internal Revenue Service. There’s an exception if you become disabled, reach the age of 65 or die.

Contributions to your HSA are either of these:

• Tax-deductible — Ex: deductible IRA contributions
• Made pre-tax — Ex: 401(k) contributions offered through an employer’s benefit plan

Earnings in the HSA aren’t taxed. Distributions you use to pay for qualified medical expenses are tax-free.

What is an HSA distribution?

As we mentioned above, you can use an HSA to pay eligible medical expenses and decrease your taxable income. The funds in these accounts belong to you, unlike medical insurance premiums, which belong to your health insurance provider. So, when you draw the HSA money, it is called a “distribution” instead of a “benefit.”

HSA benefits

However, your medical expenses might be low, and you can contribute consistently to an HSA. If so, consider these HSA advantages:

• HSA funds aren’t “use it or lose it,” like flexible spending accounts (FSAs). You can keep the funds in the account as long as you want and use them only when you need to
• There’s no waiting period before you can begin taking tax-free distributions, unlike Roth IRAs
• You might be eligible for a one-time rollover of IRA or unused FSA funds to help fund your HSA
• High deductible health plan (HDHP) premiums are often considerably lower than other common plans. This means you might have additional funds to handle the HDHP deductible and fund the HSA.
• Employers might fund some or all of the HSA for you. Employer contributions are tax-exempt

How to qualify for an HSA account eligibility

To qualify for making HSA contributions, you must have an HDHP. The HDHP:

• Must have a high deductible — For 2022, the minimum deductibles are:
  • $1,400 for self-only HDHP coverage
  • $2,800 for family coverage

The plan generally doesn’t pay medical benefits until the deductible is satisfied. A medical plan that pays for certain items without regard to the deductible isn’t a qualifying HDHP. Items might include prescription drugs or office visits.

However, exceptions exist for certain preventative or wellness benefits, like:

• Basic health check-ups
• Maintenance drugs
• Cancer screenings

An HDHP must have a maximum annual out-of-pocket expense that you can incur — For 2022, the maximum out-of-pocket healthcare expenses are:

• $7,050 for self-only coverage
• $14,100 for family coverage

Other HSA eligibility requirements include:

• You can’t be a dependent on another person’s return.
• You can’t have any other type of health insurance coverage.
• You can’t be enrolled in Medicare.
• Certain coverage is allowed, including insurance for:
  • Dental
  • Vision
  • Long-term care

There’s no earned income requirement.

The HSA-HDHP combination isn’t for everybody. It has a high deductible, and you might not have enough to fund an HSA.

The maximum annual HSA contribution for 2022 is:

• $3,650 for self-only coverage
• $7,300 for family coverage

Individuals age 55 and older may make an additional $1,000 catch-up contribution each year.

What is a Health Flexible Spending Account (FSA)?

A health FSA is an employer-established benefit plan. Your employer can offer them with other benefits as part of a cafeteria plan.

A health FSA allows you to be reimbursed for qualified medical expenses, including co-pays, eyeglasses, prescriptions, insulin, and other medical expenses not covered under your health insurance program.:

Usually, you fund your FSA through your salary. Some FSA accounts come with a debit card, which looks like a credit card. Other FSA accounts make you pay right away for a qualified expense, then you’re reimbursed later.

FSA benefits include:

• You can exclude contributions made by your employer from your gross income.
• Employment or federal income taxes aren’t deducted from the contributions
• Withdrawals might be tax-free if you pay qualified medical expenses
• You can withdraw funds from the account to pay qualified medical expenses; You can do this even if you haven’t yet placed the funds in the account

To contribute to your FSA, you should designate how much you want to contribute at the beginning of the plan year and have your employer deduct amounts, usually every payday. This will be done according to your annual designation.

You can change the amount you designate at the beginning of the plan year only if a specified event occurs, like a marriage, divorce, birth, or death of child, change in employment status, or loss of coverage under other insurance.

You aren’t taxed on the amounts you or your employer contributes to the FSA. However, you must include in your income any contributions your employer makes for your long-term medical care insurance.

You usually forfeit money you contribute that you don’t spend by the end of the plan year. So, the money is use-it-or-lose-it. However, some plans give you an additional two and a half months to use the money. Base your contribution on a sound estimate of the expenses you expect to have during the year. Due to the tax savings, an FSA might be to your advantage. This could still be true even if you’ll have to forfeit a small amount of money.

Generally, health FSAs require you to submit documentation to support the expense.

You should also retain documentation that the expense hasn’t been paid or reimbursed under any other health-plan coverage.

What are dependent-care FSAs?

You can establish an FSA to pay for dependent care, like childcare. The amount you can set aside for dependent-care FSAs usually is limited to $5,000 a year (or $2,500 for Married Filing Separately.

You’ll receive a tax advantage with a health FSA. However, dependent-care FSAs are a trade-off between pre-tax deductions and tax credits — like the child and dependent care credit.

HSA vs FSA: Tax advantages

While both account types have their purpose, you can get tax advantages with either type of account:

• Health savings accounts (HSAs) — Contributions are either:
  • Tax-deductible — You can deduct these contributions even if you don’t itemize.
  • Made with pre-tax dollars
• Flexible spending arrangements (FSAs) — Employment and federal income taxes aren’t deducted from your contributions.

FSA vs. HSA?

Thanks for following along as we’ve shared many aspects of FSA/HSA accounts. The information above should allow you to compare health flexible spending accounts vs. health savings accounts so you can understand how each works.

More tax guidance on the tax benefits of FSA/HSA

For further guidance in navigating your taxes and how a health savings account vs flexible spending account should be reported on your taxes, learn about the ways to file with H&R Block. From hands-on guidance to a do-it-yourself digital approach, we have your back.