Health Savings Accounts (HSA) and Flexible Spending Accounts (FSA) are both tax-advantaged ways to pay health expenses. But one is clearly better.
It's good to have options for saving money you can use before retirement. HSAs and FSAs are the two main choices you have.
Let's dig into the details and compare to see which one has the advantage.
Can You Deduct Your Contribution?
Both FSA and HSA accounts let you deduct your contribution from your gross income.
So if you make $50,000 and contribute $2,000, your gross taxable income will only be $48,000. This is the same tax treatment as a deductible IRA or 401k contribution.
This is referred to as a pre-tax contribution, since the money is taken out before payroll taxes.
How much can you contribute?
A higher contribution limit into a tax-advantaged account has two benefits.
First, you reduce your taxable income more. Second, you have more money that can be spent tax-free for qualified expenses.
In this regard, the HSA account is the winner.
For 2019, the Health Savings Account contribution limit is $3,500 (individual) or $7,000 (family). For a Flexible Spending Account the contribution limit is $2,700.
If you're age 55 or older you can increase your HSA contribution by $1,000 per eligible person. That would be $4,500 and $9,000 (individual and family). You can't do that with a Flexible Spending Account.
Investing your money in a tax-deferred account is one of the best ways to build wealth. Tax-deferral allows you to earn interest, dividends or capital gains (growth of stocks) and not report them on your taxes.
In this respect, the HSA account has a clear advantage.
You can invest your HSA money in the stock market and let your earnings compound over time. In the FSA account you cannot.
Use Money for Childcare Expenses?
Childcare costs are a huge expense for some. Using pre-tax dollars to pay for daycare saves you money.
The Flexible Spending Account allows you to use your contribution for childcare. With a Health Savings Account this is not allowed without taxes and penalties.
So for childcare expenses, the FSA account is the winner.
Can You Keep Money You Don't Spend?
One big difference between HSA and FSA accounts is whether you can keep the money you don't use for the following year(s).
In a FSA, any money you don't use will be forfeited. Yes, gone.
You may feel compelled to spend all the money, even if you don't need it. That is not the financial behavior you want to encourage!
With an HSA account, the money is always yours. You get to keep it compounding year to year if you don't spend it. If you leave your job, you can take the money with you. Actually the money is held with a third party company, so it's already yours separately.
Use Money for Retirement?
Since you can't rollover your FSA account money to the following year, you obviously can't use it for retirement.
But with an HSA account you can.
Though the primary purpose is paying for healthcare expenses, you can use your Health Savings Account money for retirement income. You just have to be 65 or older.
You will have to pay income tax on those income withdrawals, but no penalty.
That makes HSA accounts a good complement to your other retirement accounts.
Summary of FSA vs HSA Comparison
FSA and HSA accounts are two options to save pre-tax money that you use before retirement.
But the HSA account has the clear advantage when you compare details. From the contribution limit, investment options, and ability to use for retirement, a Health Savings Account beats the Flexible Spending Account.
The only advantage the FSA has over the HSA is using the money for childcare costs.
Otherwise, an HSA account is the clear winner.
HSA accounts are a great option to help you with medical expenses and retirement.
Do you have any questions about FSA or HSA accounts? Leave them in the comments below.