Q. What is the difference between a Medical FSA and a health savings account (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.
- 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. The ACA implemented a rule as of 2011 that prohibited the use of FSA funds to purchase over-the-counter medications, unless a doctor wrote a prescription for them. But Section 4402 of the 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act changed that, allowing pre-tax FSA funds to be used for over-the-counter drugs without a prescription. This is retroactive to January 1, 2020, and is a permanent change. Section 4402 of the CARES Act also changed the rules to allow menstrual products to be purchased with FSA funds.
- “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 (if the plan doesn’t follow the calendar year, money has to be used up by the end of the plan year; alternatively, the employer can allow up to $500 to be carried over to the next plan year or give employees 2.5 months at the start of the next plan year to use up money remaining in the account).
- In the past, employers could set their own FSA contribution limits for their employees. But the ACA limits contributions to no more than $2,750 in 2020 (this is adjusted annually for inflation by the IRS; it started at $2,500 in 2013). The American Health Care Act, which passed in the House in 2017 but did not pass in the Senate, would have eliminated the contribution limits.
- 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.
- Can be established by an employer or by an individual, but only in conjunction with an HSA-qualified high deductible health plan (HDHP). But the HSA administrator (bank, investment firm, etc.) does not have to be in any way affiliated with the insurance company that offers the HDHP. And even people who have an HSA through their employer are free to transfer the money to a different HSA administrator if they choose to do so.
- 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 2020, maximum HSA contribution is $3,550 for a person with individual coverage under an HDHP, and $7,100 for those with family HDHP coverage (“family” means the HDHP covers the primary enrollee plus at least one additional family member; it does not have to cover the whole family). For 2021, the contribution limits are increasing slightly, to $3,600 and $7,200.
- If an HSA is established by an employer and the employee quits or is terminated, the HSA balance 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, from 2011 through 2019, a doctor’s prescription was necessary in order to use pre-tax HSA funds to buy over-the counter medications. But the CARES Act relaxed that rule, allowing over-the-counter medications (and menstrual products) to be purchased with HSA funds.
- 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.
- 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.
- Republican health care reform proposals have generally called for an increased focus on HSAs, with higher contribution limits and greater flexibility. But as of 2020, none of those measures had been implemented. The GOP’s efforts to repeal the ACA in 2017 were unsuccessful, and the tax bill that Republican lawmakers passed in December 2017 did not make any changes to the rules pertaining to HSAs (it did repeal the ACA’s individual mandate, however, effective in 2019).
Louise Norris is an individual health insurance broker who has been writing about health insurance and health reform since 2006. She has written dozens of opinions and educational pieces about the Affordable Care Act for healthinsurance.org. Her state health exchange updates are regularly cited by media who cover health reform and by other health insurance experts.