Whether you’re an employer who wants to educate employees on the difference between a Flexible Spending Account (FSA) and Health Savings Account (HSA) or an employee considering the pros and cons of these accounts, it’s crucial to understand them.
Both employee benefits offer tax advantages, as the contributions are made on a pre-tax basis. However, HSAs and FSAs each provide unique benefits. So, we’ve put together a simple guide explaining FSAs, HSAs, options, and who would benefit from each.
What is a Flexible Spending Account (FSA)?
An FSA allows employees to set aside pre-tax money for certain health care and dependent care expenses not covered by insurance. The election amount is divided into allotments based on the number of pay dates in the plan year. The portion of the employee’s paycheck is deposited into their FSA account every pay period.
Types of FSAs
Health Care FSA (HCFSA)
- Most common type of FSA, which employees can use for out-of-pocket medical expenses (e.g., copays, prescriptions, deductibles, etc.)
- Employee has access to total funds on the first day of the plan year, like a line of credit
- Cannot be combined with an HSA
Limited Purpose FSA (LPFSA)
- Works like an HCFSA, but funds can only be used for vision and dental expenses
- Can also be combined with an HSA
Dependent Care FSA (DCFSA)
- Allows employees to pay for employment-related dependent care services (e.g., daycare, preschool, summer camps, non-employer-sponsored before or after school programs, etc.)
- Funds may be used for expenses for children under age 13 or individuals who are unable to care for themselves and live with the account holder more than half the year
- Can only use funds that have already been contributed through payroll deductions
- Maximum contribution limits are set by statute and not subject to cost of living adjustments (COLAs)
- Must be established by the employer
- Typically funded entirely by the employee’s payroll deductions, but an employer may contribute
- Maximum annual contribution limit with annual COLAs
- May be used on any qualified medical care expenses, not including health insurance premiums (see IRS Topic 502)
- Unused funds are typically “use it or lose it”*
- Tied to employment and are not maintained if the employee separates from the employer
- FSA expenses must be backed up—so keep those receipts!
*Note that employers have the option to provide a plan that includes a two-and-a-half-month grace period to spend remaining FSA funds OR to allow participants to carry over unused funds at the end of the plan year, up to a limit set by the IRS. Your plan can elect either the grace period or rollover option, but not both.
Below are the FSA contribution limits for Health FSAs for 2021 and the adjustments recently announced for 2022.
|Health FSAs & LPFSAs||2022||2021|
|Maximum salary contribution limit||$2,850||$2,750|
|Maximum rollover limit||$570||$550|
As for DCFSAs, the American Rescue Plan Act (ARPA) increased contribution limits for 2021, applicable to the plan year starting after December 31, 2020, and before January 1, 2022. The 2022 DCFSA maximum will return to normal limit amounts.
|Dependent Care FSAs||2022||2021|
|Maximum salary contribution limit (single taxpayers and married couples filing jointly)||$5,000||$5,000 (but increased to $10,500 due to ARPA)|
|Maximum salary contribution limit (married couples filing separately)||$2,500||$2,500 (but increased to $5,250 due to ARPA)|
COVID-19 Relief Adjustments
- Allow employees enrolled in health or dependent care FSAs to rollover unspent balances from a plan year ending in 2020 to a plan year ending in 2021, and to rollover funds from a plan year ending in 2021 to a plan year ending in 2022. Employers can choose to provide either or neither of these carryover extensions.
- Extend the grace period for spending unused FSA balances to 12 months for plan years ending in 2020 or 2021.
- Allow employees who stopped participating in a health FSA during 2020 or 2021 to use unspent balances through the end of the plan year in which their participation ended, including any extended grace periods.
Who Could Benefit from an FSA?
While everyone’s needs vary, FSAs are often a great fit for individuals or families who have frequent doctor visits and medical expenses. They can be especially beneficial for those with ongoing medical conditions.
An FSA is also a good supplemental option for those with a low-deductible health plan, making them ineligible for an HSA that requires a high-deductible health plan.
Some people invest in both an LPFSA (e.g., those with higher vision and/or dental costs) and an HSA. This ensures that they can cover expenses like glasses and dental work while enjoying substantial savings in an HSA for future medical needs.
What is a Health Savings Account (HSA)?
An HSA is an investment account available only to those enrolled in a high-deductible health plan (HDHP) and under the age of 65. Employees can use these funds to pay for their plan deductible and/or qualified medical expenses that do not count toward their deductible.
- Employer can offer an HSA or individuals can start an account on their own
- Puts a portion of the employee’s premium toward their HSA, with the option to make additional pre-tax contributions
- Can only spend money you’ve already saved
- Some HSAs even earn interest
- Remaining balance rolls over from year to year—the money is always yours to keep!
- Withdrawals can be used for non-medical expenses but are subject to income tax (if you are under age 65, there is an additional 10% tax penalty)
- Once you are 65, you can cash your HSA and invest the funds in your IRA
Who Could Benefit from an HSA?
An HSA is a cost-effective benefit for healthy (often young) individuals who do not have a lot of medical expenses. It’s a solid choice for those who only visit their doctor for annual check-ups and preventive care. Of course, it is also a smart option for those nearing retirement, as they can use the funds to offset the costs of medical care after retirement.
Overall, people with a low-cost HDHP, a requirement to qualify for an HSA, are good candidates for HSA plans.
HSA vs. FSA: What to Offer
Many employers offer at least an HSA or FSA plan to give employees the option to prepare for and supplement their medical costs. If you are considering adding one or both accounts to your benefits package but have more questions, contact BlueLion today at 603-818-4131 or firstname.lastname@example.org! Our HR specialists will help you navigate and develop your HSA and/or FSA plan.
The information on this website, including its newsletters, is not, nor is it intended to be legal advice. You should contact an attorney or HR specialist for advice on your individual situation.