Much like a Rubik’s Cube from the 80s, understanding Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) can seem like an overwhelming puzzle. But don’t despair: like Tom Hanks in ‘Big’, we’re going to navigate the complexities of adulting, starting with demystifying HSAs and FSAs.
One of the biggest advantages of both HSAs and FSAs is that they offer tax savings for employees and employers. However, each account has unique features and relative benefits, which can make it difficult to choose between the two.
Here are some key points to consider when determining whether a HSA or FSA is better for your business:
Eligibility
HSA: Only employees enrolled in a High Deductible Health Plan (HDHP) are eligible to contribute to an HSA.
FSA: Anyone who is offered a health plan through their employer can participate in an FSA.
Dependent Care FSA: In addition to the Healthcare FSA, employers can also offer a Dependent Care FSA for employees with dependents who require care.
Defining HSA and FSA
Health Savings Account (HSA): This is a personal savings account that works in conjunction with a High-Deductible Health Plan (HDHP). It allows you to set aside pre-tax dollars for qualified medical expenses. The funds in an HSA roll over from year to year, and you can even invest the money for potential growth.
Flexible Spending Account (FSA): This is an employer-managed account that allows employees to use pre-tax dollars for eligible healthcare expenses. However, unlike an HSA, unspent FSA funds typically do not roll over and must be used within the plan year.
How They Work
HSAs and FSAs work by allowing you to contribute pre-tax dollars, which you can then use to pay for eligible healthcare expenses.
HSA: You can use a debit card or check linked to the HSA to pay for expenses, or pay out of pocket and request reimbursement from the account. Any funds not used roll over to the next year.
FSA: You may also have a debit card for these transactions and will need to provide a written statement from a third party validating the expense (sometimes this is done automatically), and a claim that the expense isn’t covered by any other healthcare plan. If you have leftover funds at the end of the year, your employer gets it back, but they also take the liability for front loading the funds at the beginning of the year.
The Differences
The major differences between an HSA and an FSA lie in their flexibility, contribution limits, and rollover rules.
HSA: Generally, HSAs offer higher contribution limits and more flexibility. For instance, you can change your contribution amount anytime during the year, and the unused funds roll over to the next year.
FSA: FSAs have lower contribution limits, and you can’t carry unused funds forward. However, FSAs do not restrict the type of healthcare plan a company must offer.
As for potential pros and cons, it depends on a couple of factors.
HSA: If you have a HDHP, an HSA allows for larger contributions and additional flexibility to carry over funds. However, this plan is only available if you have a HDHP.
FSA: If a HDHP does not make sense for your employee base, a traditional healthcare plan and an FSA may yield better utilization and employee satisfaction.
The Annual Maximums & Taxes
Annual Contribution Limits
The Internal Revenue Service (IRS) sets annual contribution limits for both HSA and FSA accounts. These limits may vary each year due to inflation adjustments.
HSA: For 2024, the IRS set the HSA pre-tax contribution limits at $4,150 for individuals and $8,300 for families. This allows eligible participants to protect larger portions of their income from taxation, provided they use the funds for qualifying medical expenses.
FSA: For 2024, the IRS allows individuals to contribute up to $3,200 to a health FSA on a pre-tax basis. Unlike HSAs, FSAs do not have a separate contribution limit for families.
Tax Implications
HSAs and FSAs offer unique tax advantages that can help individuals and families manage healthcare costs.
HSA: Contributions to an HSA are made pre-tax, reducing taxable income. Additionally, withdrawals for qualifying medical expenses and earned interest are tax-free. For instance, if you make $100,000 in a year and contribute $5,000 to an HSA, you would only pay federal taxes on $95,000 of your income.
FSA: Like HSAs, contributions to an FSA are also pre-tax. However, unlike HSAs, FSAs do not offer tax-free interest. Withdrawals for qualifying medical expenses are tax-free.
Rollover Rules
One major difference between HSAs and FSAs is how they handle unused funds at the end of the plan year.
HSA: HSAs offer the advantage of allowing unused funds to roll over from year to year. This feature enables account holders to save for larger, future health expenses.
FSA: Usually, unspent FSA funds do not roll over and must be used within the plan year, or else they are forfeited back to the employer. Some employers, however, may offer a grace period or a carryover of up to $550 into the next plan year.
Mistakes to Avoid
The most common mistake when using or setting up an HSA or FSA is not understanding the fine print. Make sure to understand the eligible expenses, contribution limits, and rollover rules for both accounts. Another mistake is failing to use FSA funds before the end of the year.
Remember, there’s no one-size-fits-all answer. If you need help navigating the maze of employee benefits, don't hesitate to reach out for a consultation. When it comes to HSAs and FSAs, I'm your guy.
