How do you choose which benefit to offer your employees: an FSA or an HSA? It’s the age-old question that’s whispered inside every office in every city in every state at least once a year.
While the two acronyms may sound like the exact same thing, that little F or H changes everything. FSAs and HSAs are both tax-advantaged medical savings accounts, meaning that they help you and your employees save serious money on health-related expenses.
Many companies pour them into their benefits packages to help their team better budget their health needs throughout the year.
But should you offer them too? And if so, which one should you and your employees pick? We’ve got some answers.
Let’s get down to business. What’s an FSA?
A Flexible Spending Account (FSA) is a special account that you can place pre-tax money into in order to pay for IRS eligible, out-of-pocket expenses. Because this money is pre-tax, you don’t pay any taxes on these accounts (unless you use it for an ineligible expense), saving you money in the long run.
Overall, there are three types of FSAs:
- Health FSA: Allows for contributions to be utilized for eligible medical expenses, such as a copay, prescription drugs, or certain over-the-counter medications or first aid items. The IRS provides a list of eligible medical expenses for health FSA coverage.
- Dependent Care FSA: Contributions can be spent on child care expenses for children under the age of 13 (or 14, depending on your plan) or the care of a spouse or dependent of any age who is physically or mentally incapable of self-care. IRS Publication 503 provides more information on dependent care FSA eligible expenses.
- Limited Purpose FSA: A limited-purpose FSA (LPFSA) is a type of FSA that covers only specific health expenses, unlike a general-purpose health FSA, such as vision and dental expenses.
This post is going to focus on health FSAs and limited purpose FSAs.
Read more on Dependent Care FSAs.
Learn more on the differences between HSAs and FSAs.
How funding works
Health FSAs are considered a benefit plan; therefore, an employer is required to “sponsor” it: similar to a traditional medical, dental, or vision group plan. The employer (or plan sponsor) sets forth the eligibility standards an employee must meet in order to enroll in an FSA, such as a waiting period or hours required to work.
Employees enrolled in an HSA can also be enrolled in a limited purpose FSA (LPFSA) to cover vision and dental health expenses. Enrollment in any other type of health flexible spending account is not permitted in conjunction with an HSA to maintain HSA eligibility.
One note to keep in mind is that certain limitations may apply if you’re a highly compensated participant or a key employee.
How funding works for a health FSA
A participant contributes to their health FSA by electing an amount to have their employer withhold from their pay. At the beginning of the plan year, participants must designate how much they want to contribute, and then their employer will deduct amounts periodically. The maximum annual contribution limit for 2021 is $2,750 per employee.
It is important to note that participants cannot change or revoke their election unless they experience a qualifying life event. If a participant changes jobs, they can still change how much they contribute for the year up to the maximum contribution. This is allowed even if they elected to contribute the maximum amount at their previous job.
Employers can choose—but are not required—to contribute to a health FSA or an LPFSA. The employer and employee contributions to the health FSA or LPFSA together cannot exceed the IRS maximum.
Okay. Now, what exactly is an HSA?
An HSA, or Health Savings Account, is similar to a health FSA in that it lets you set aside pre-tax money to pay for eligible out-of-pocket medical expenses. These expenses include copayments and other amounts, but not premiums. The main difference between a health FSA and an HSA is that in order to enroll in an HSA, you must already be enrolled in an HSA eligible High Deductible Health Plan (HDHP).
In short, HDHPs are health plans that usually have lower monthly premiums, and higher deductibles, and out-of-pocket max limits than other plans, like a PPO or EPO.
Who is eligible for an HSA?
Anyone enrolled in an HSA-eligible HDHP is eligible for an HSA.
By law, you are not eligible for an HSA if you are:
- enrolled in Medicare;
- covered by another health plan that is not an eligible HDHP;
- in receipt of VA or Indian Health Services (IHS) medical benefits within the past 3 months;
- covered by your own or your spouse’s health FSA that is not an LPFSA;
- claimed as a dependent on someone else’s tax return;
- covered by a non-HDHP such as TRICARE/TRICARE For Life.
Note: Not all HDHPs are HSA eligible. Please reach out to your carrier, broker, or employer if you have questions on if your plan is HSA eligible.
FSAs and HSAs at a glance
| FSA | LPFSA | HSA | |
|---|---|---|---|
| Enrollment eligibility |
| Employer must offer as a benefit | Must be enrolled in an HSA eligible High Deductible Health Plan (HDHP) |
| Eligible expenses | IRS eligible out-of-pocket medical expenses | IRS eligible dental and vision expenses | IRS eligible out-of-pocket medical expenses and various types of health insurance premiums |
| Max Annual Contribution (2021) | $2,750 | $2,750 | $3,600 for self-only coverage; $7,000 for self and family coverage; additional $1,000 is allowed for those 55+ |
| Who contributes | Employees and Employers | Employees and Employers | Anyone |
| Who owns the money | Employer | Employer | HSA Account Holder |
| Rollover & grace periods |
| Same as Health FSA | Money remains in the account until withdrawn |
| Money availability | At the beginning of the plan year once the participant has determined their annual contribution amount. The full amount of money is available even if the participant has not yet contributed to the account. This is called “pre-funded.” | Same as Health FSA | The money becomes available as the participant contributes to the account. Thus, the participant only has access to the amount of money actively in their account. This is called “post-funded.” |
For a more in-depth description of HSA and Health FSA plans, see our Gusto Blog article on the Differences Between HSAs and FSAs.
I’m feeling good about the differences. But which one should I choose for my team?
An employer can offer both an HSA and a health FSA. Employees, though, may be limited as to what they can enroll in depending on their plan.
The important reminder here is that employees must be enrolled in a high-deductible health plan to qualify for an HSA. If an employer does not offer an HDHP, then it might not be as effective to offer an HSA, as the employee would be responsible for enrolling in an eligible HDHP outside of the employer.
If an employer does offer high-deductible health plans, then the short answer is: the choice depends on the makeup of an employer’s employee base.
What if I have an HDHP with an HSA and another type of health insurance plan?
HSAs are typically not allowed to be paired with any type of insurance other than the requisite HDHP. However, in this scenario, you do have the option of a Limited Purpose FSA. Since these types of FSAs only cover dental and vision, it does not violate the “no additional coverage” rule for HSAs.
The person who knows they may need to use funds this year
Let’s say your employee is pregnant, needs to have their wisdom teeth taken out, or has some other expected medical procedure. A health FSA may be a good option because they can immediately access the money when they need it. Just remember that an HSA allows your employee to contribute more money to it than a health FSA allows.
The person who may not know if they’ll need to use funds
An HSA might be a better fit for this employee. Because folks can only access their HSA money as they contribute to it, it makes more sense to go this route for the employee who isn’t expecting a lot of immediate medical expenses. Likewise, the money is not “use-it-or-lose-it.” Even if you are no longer eligible to contribute, you may continue to use funds from the HSA.
Some good questions to ask when deciding
- Will I have a lot of medical expenses this year?
- Do I have dependents?
- Will I want to be able to save and potentially invest this money in the future?
How do I actually set up an FSA or HSA?
As an employee, an FSA Plan must be offered by your employer. From there, you can choose to opt-in and then designate how much you want to contribute at the beginning of the plan year.
To qualify for an HSA, you must first be enrolled in a high-deductible health plan. Once you’re enrolled in an eligible plan, you can set up an HSA–either through your employer or one you set up outside of your employer.
As an employer, once you have an idea of which account is right for you and your team, give your health insurance broker a ring. Let them know which one you’re thinking about setting up, along with any special features you want to layer on top. Your broker will walk you through the accounts available to you based on your current health insurance plan, in addition to all costs associated with it.
Now, hopefully, you can feel a lot calmer about the FSA or HSA debate. With this breakdown, you’ll be able to pinpoint the plan that works best for your company while empowering your team to do what makes the most sense for them too.
Have any updates been made to health FSAs and HSAs during COVID-19?
Yes! The Coronavirus Aid, Relief, and Economic Security (CARES) Act made changes to both health FSAs and HSAs intended to provide more coverage and money flexibility. Some of these changes are temporary, while others are more permanent.
The CARES Act expanded qualifications for health FSA out-of-pocket medical expenses to include both prescription and non-prescription over-the-counter drugs, as well as menstrual care supplies. This is a permanent allowance.
Keep in mind that not all over-the-counter drugs are eligible; for example, vitamins and supplements are not considered eligible unless prescribed and sustained by a physician to treat a medical condition. Review a list of eligible and non-eligible medical expenses.
HDHPs can also now be paired with HSAs to cover telehealth services before a patient has met the plan deductible.
All of these changes listed above are permanent and apply retroactively to purchases beginning Jan. 1, 2020.
Read more about changes to recent FSA rule changes.
Another note about COVID-19: While the 2020 COVID relief bill granted temporary, optional exceptions and changes to health FSAs in 2021 and 2022, Gusto is currently not supporting the following amendments.
- Employees can carry over all unused funds from health FSA plan year accounts to 2022 plan year accounts.
- Employers can extend the grace period to 12 months after the end of the plan year for the 2021 plan year.
- Employers permit terminated employees with remaining contributions in their health FSAs during calendar year 2020 or 2021 to receive reimbursements for eligible expenses incurred through the end of the plan year in which they were terminated, including any applicable grace period (such as an extended grace period adopted by the employer).
- Employers can permit health FSA participants to make prospective changes to their elections for plan years ending in 2021 without regard to any change in status.
