HSAs vs FSAs
While health insurance covers a portion of medical expenses and reduces the out-of-pocket costs for patients, HSAs and FSAs are there to cover what remains. They each offer unique benefits to account-holders, but both provide tax-free money employees intend to use toward medical expenses. Automatic deductions from payroll are deposited before they are taxed, and additional contributions are tax-deductible.
For both accounts, if the money is used for qualified medical expenses, this money remains tax-free. Aside from this, there are some significant differences between HSAs and FSAs, so the benefits to employees and the company should be weighed carefully when deciding if one, or both, will be offered as part of your benefits package.
What is an HSA?
HSAs are structured similarly to a personal savings account, with a few key differences. Like a personal account, money can be deposited and withdrawn, but the rules that govern the HSA are determined by the Internal Revenue Service (IRS). If these rules are followed, an HSA is an excellent way to save money for future medical expenses and even retirement.
Here are the benefits an HSA offers employees:
- The account is owned by the employee and remains open even when the employment period ends. This means the account holder can continue contributions and withdrawals until they decide to close the account, regardless of their employment status.
- HSA contributions are tax-free, further stretching the value of the money in the account.
- Money contributed to the HSA can be invested, further increasing the potential growth of the account. As long as withdrawal rules are followed, any gains are tax-free.
- Money invested in the HSA rolls over in full at the end of the year, allowing the account to continue to grow.
- Account holders who are 65 or older can withdraw money for nonmedical purposes, without penalty, paying only the standard income tax rate. This means the HSA is an excellent option to add to a retirement portfolio.
- Unlike a 401(k) or traditional IRA, there are no minimum distribution requirements (RMDs). Your money can stay invested at your discretion without paying a penalty for failing to withdraw the required amount each year if you are over the age of 72.
- Some employers choose to contribute to employee HSAs, further increasing the value for employees.
- The account can be used to pay dependent medical expenses as well.
There are also limitations of HSAs to be aware of:
- Individuals must qualify to open an HSA. These accounts are limited to those who are enrolled in a high deductible health plan (HDHP), are not covered by additional health plans except those allowed by the IRS, not enrolled in Medicare and not claimed as a dependent on someone else’s tax returns.
- HSAs are subject to annual contribution limits. These limits vary depending on the age of the account holder and whether the account is considered for personal use or a family account. Any contributions above these limits are exempt from the tax-free benefits.
- Money can be withdrawn from an HSA for any purpose, but only qualified medical expenses retain the tax-free benefit. Money used for non-qualifying expenses is taxed at the normal rate.
- Any contributions made by an employer will reduce the number of tax-free contributions allowable to the account holder for the year.
- Annual contributions are limited to $3,600 for individuals and $7,200 for families. Those over the age of 55 are allowed an additional $1,000 per year.
- Employer contributions are limited to the maximum allowable for the year.
What is an FSA?
FSAs are meant to provide the same gap coverage for out-of-pocket medical expenses, but they’re structured more like a credit account. Beneficiaries can begin using the credit amount for eligible expenses immediately, but the money must be repaid before the end of the year. Like the HSA, the IRS determines the rules surrounding FSA use and offers unique tax benefits to those who work within the set guidelines.
Here are some of the benefits offered to the recipient:
- Money, up to the maximum allowable by the IRS, is available to use on covered expenses as soon as the account is opened, regardless of the contributions already made.
- The maximum amount is made available again at the start of each new year.
- Money contributed to the FSA is tax-free.
- Some employers will contribute to the FSA, and that will not reduce the covered individual’s allowable contribution.
- Some companies will allow FSA funds to be used for childcare costs.
- FSAs can be used with any type of health care coverage or even on their own without a health care plan.
Also, like the HSA, the FSA comes with a number of limitations, including:
- The account cannot belong to the beneficiary and is tied to the individual’s place of employment. Once employment status changes, any usage that exceeds contribution is owed by the individual.
- Money does not roll over and must be used by the end of each year or risk being lost. For some employers, up to $550 may roll over for the year, or unused funds may have a grace period of up to two-and-a-half months.
- The maximum annual contribution amount is $2,750.
- Employers can contribute up to $500 to the FSA regardless of the amount the employee contributes. Anything above that amount cannot exceed the employee contribution.
Benefits to your business
Now that you understand the differences between the two accounts for your employees, you may be curious about the HSA vs. FSA benefits to your company. First, it’s important to understand that your company is not required to offer either option but is allowed to offer both. If you choose to offer both, employees will need to decide which account they prefer, because they can only have both if using a limited-purpose FSA.
Companies that offer these accounts can enjoy the following benefits:
- Pretax employee contributions will lower payroll taxes.
- Company contributions are tax-deductible.
- These accounts help employees save for necessary medical expenses, resulting in healthier employees with fewer missed days due to illness and injury.
- They add a competitive edge to your offered benefits package, helping to recruit quality employees.
- HSAs are offered with HDHPs and offer incentive for employees to choose these plans. This results in significant savings in premiums for the company.
Which should you offer?
When deciding between HSA vs. FSA, which plan you choose to offer largely depends on who you employ and the health insurance options you have available. There are a few situations where one, or the other, might be the best option.
It may help to ask yourself the following questions when deciding which accounts to offer:
- Are you offering an HDHP? Employees who are not enrolled in an HDHP are not eligible to open an HSA. If your company doesn’t offer this coverage option, you are limited to offering employees an FSA.
- Are your premiums too high? Choosing to offer an HSA could help incentivize employees to enroll in the cheaper plan, saving you money. Some companies will even use a portion of the savings to contribute to the HSA, making the option even more attractive.
- Do you have a high turnover rate? HSAs belong to the employee but FSAs belong to the employer. If an employee has an FSA and chooses to leave without using the balance of the FSA, the money is forfeited to the company. On the other hand, if money has been spent through the FSA and has not yet been paid back, the employee owes that upon termination. This could encourage employees to spend more time with the company.
- Is your business small enough to exempt you from offering health insurance? If so, you could still offer your employees an FSA to help with medical costs.
- Does your company employ individuals with small children? FSA funds can also be used to pay for childcare, creating more options for young parents and helping to prevent missed days from lack of care services.
The bottom line
The choice between FSA or HSA for companies really depends on what you hope to accomplish. Although some situations may call for offering only one or the other, offering both is often the best choice, allowing you and your employees to reap numerous potential benefits. This provides employees with greater control over their health care, increases the incentive for prospective applicants, improves the quality of new hires and ensures your current staff has the best chance of avoiding missed time due to illness or injury.
Offering both also sends the message to your employees that you’re invested in supporting their best interests, which can encourage professional loyalty. Remember, employees who feel valued are often a company’s best assets.