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What is the difference between a Medical FSA and an HSA?

Q. What is the difference between a Medical FSA and an HSA?

A. Both FSAs and HSAs are tax-advantaged accounts that allow people to save money to pay for qualified medical expenses, but they have several key differences. The ACA implemented some new restrictions on FSAs and HSAs that could be eliminated if the ACA is repealed.

Flexible Spending Accounts (FSAs)

  • Established by an employer.
  • Usually funded by pre-tax payroll deduction, but employers can also contribute.
  • Can be used in conjunction with any type of health insurance, although health insurance coverage is not required.
  • FSA funds can be used to cover deductibles, copays and coinsurance, as well as qualified medical expenses that are not covered by health insurance, such as LASIK eye surgery. Prior to 2011, FSA funds could be used to purchase over-the-counter medications, but now they can only be used for OTC medications if a doctor has prescribed them (a reconciliation bill to repeal the ACA could eliminate this requirement; H.R.3762, passed by Congress in 2016 but vetoed by President Obama, would have removed the restriction on using FSA funds for OTC meds).
  • “Use it or lose it” – money not used by the end of the year (or by March 15th of the following year if the employer offers a grace period) is forfeited, although employers can allow enrollees to carry over up to $500 to the next year instead of allowing FSA funds to be used as late as March 15 of the following year.
  • In the past, employers could set their own FSA contribution limits for their employees. But the ACA limits contributions to no more than $2,600 in 2017 (in 2015 and 2016, the limit was $2,550, but there was an inflation adjustment for 2017). This provision could also be eliminated by a reconciliation bill to repeal the ACA, and would have been eliminated by H.R.3762.
  • Contributions are deducted from each paycheck throughout the year.  However, the full annual contribution amount is available for use immediately (or after the first contribution is made).  If the employee uses the full amount and then quits or is terminated prior to the end of the year, FSA funds do not have to be paid back to the employer.

Health Savings Accounts (HSAs)

  • Can be established by an employer or by an individual, but only in conjunction with an HSA-qualified high deductible health plan (HDHP).
  • Contributions can only be made while the account holder remains covered by an HDHP.  However, the money can be used — without being taxed — for qualified medical expenses at any time in the future, even if the person is no longer covered by an HDHP.
  • Can be funded (pre-tax) by employee payroll deductions or employer contributions, or by an individual.
  • In 2017, maximum HSA contribution is $3,400 for an individual (up from $3,450 in 2016), and $6,750 for a family (unchanged from 2016).
  • If an HSA is established by an employer and the employee quits or is terminated, the HSA  goes with the employee, regardless of whether contributions were made by the employee or the employer.
  • Money in the HSA that is not used for medical expenses remains in the account.
  • HSA funds can be used for the same qualified medical expenses as FSA funds. And just like FSAs, prior to 2011, HSA funds could be used to purchase over-the-counter medications, but now a doctor’s prescription is required in order to use HSA money to buy OTC medications (as with FSAs, this provision could be eliminated by a reconciliation bill to repeal the ACA).
  • If money is withdrawn for qualified medical expenses, it is never taxed.
  • If money is withdrawn for other purposes prior to age 65, it is taxed and there is an additional 20 percent penalty applied. Prior to 2011, the penalty was 10 percent. A reconciliation bill to repeal the ACA could end up changing the penalty back to 10 percent; H.R.3762 would have done so, but was not enacted — a similar bill is much more likely to be enacted under the Trump Administration.
  • After age 65, money can be withdrawn without a penalty, but if it is not used for qualified medical expenses, income taxes will be owed.
  • Most Republican health care reform proposals call for an increased focus on HSAs, with higher contribution limits and greater flexibility. We don’t yet know the details of the plan that Congressional GOPs are planning to put forth to replace the ACA (assuming they do repeal it), but there’s a good chance that it will include a greater emphasis on HSAs.