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Medical Expenses

Help Clients Understand HSA and FSA Differences


To help clients decide between an HSA or an FSA, you must first explain the similarities and differences between the two options. This article is a discussion that can help you explain the details of both types of accounts.

Aug 2nd 2021
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As an accountant and trusted advisor, you are in a perfect position to advise your clients on opting for a Health Savings Account (HSA) or a Flexible Spending Account (FSA) to save on medical costs.

People with health insurance policies can use both HSAs and FSAs to set aside money for qualified medical expenses. This may include copayments, coinsurance and deductibles, along with monthly prescription costs.

They are pretty convenient and, in most cases, the account holder receives a debit card to pay for qualified medical expenses. Both these accounts can help manage out-of-pocket medical expenses.

Here are a few more similarities between the FSA and HSA:

  • Individuals make pretax contributions to both accounts
  • The contributions are tax deductible
  • Both of these accounts are available through employers
  • Usually, both have the same list of "qualified expenses"
  • There is currently an annual contribution limit

How Does an HSA Differ From an FSA?

Here are the primary differences:

  HSA FSA                              
Qualifying Criteria Requires a high-deductible health plan (HDHP).Can’t be listed as a dependent on someone else's tax return.Can’t be eligible for Medicare. Employer has to offer this.
Ownership of Account Employment changes don't affect it since the account is owned by an individual.The individual need not be employed to contribute as long as he/she has an HDHP. If not eligible for continuing COBRA, the account may get lost with a job change since owned by the employer.
Changing the Amount of Contribution Can change any time throughout the year. Can be adjusted only at open enrollment or if there’s a change in family status or employment.
Rules of Rollover Unused balances can be rolled over every year. Can’t roll over unused balance unless allowed by employer, capped at $500.Employees get a grace period of 2 ½ months to use the remaining fund.
Withdrawal Penalties Can withdraw an amount tax-free after 65 years. If withdrawing before 65, an individual has to pay a 20-percent penalty for nonmedical expenses and needs to declare it on their income tax form. May need to submit expenses to be reimbursed.Depending on the employer, individuals don't have access to funds for nonmedical expenses.
Tax Impact Tax-deductible contributions, but can be taken out of gross pay pretax, too.Growth and distributions are tax-free. Pretax contributions and distributions are not taxed.
Annual Contribution Limit For 2021, up to $3,600 per individual with self-only coverage under an HDHP. For 2021, up to $2,750 per individual.

How to Decide Which One to Use

First off, HSAs are better for healthier and younger people with few medical conditions. It is also a better option if your client wants to build cash value that he or she can use after retirement.

HSAs are relatively more flexible. Your client can save money in several ways. He or she will pay fewer taxes. It will help your client in the long term since unused money gets rolled over every year, offering potential for greater savings.

FSAs don’t allow an account holder to build money over time since you lose the remaining funds every year. Also, there’s a chance of losing money with changes in employment. However, the HSA offers the freedom to change employers without affecting the account. Usually, a person never loses money with an HSA.

If your client has to bear upfront medical costs, it is better to go with an FSA. The FSA funds are accessible on the first day of the plan year.

You may experience a common question from your client: Can anyone have both accounts simultaneously? Only if it is a limited-purpose FSA. This means the FSA should have a definite purpose, such as covering long-term care costs instead of regular medical costs.

Are there any changes in rules due to the pandemic? The Coronavirus Aid, Relief, and Economic Security (CARES) Act now allows HSA funds to be used for over-the-counter medications even without a prescription.

According to the Consolidated Appropriations Act, 2021, taxpayers can roll over the unused portion of their FSAs from 2020 to 2021 and 2021 to 2022. This also allows employers to give employees the opportunity to make a mid-year change in contribution amounts. Employers will have to adjust policies to account for these new changes. 

If necessary, you can talk to your clients about tax implications regarding the withdraw penalty and how to include it on their tax form. This can give them a clear picture and help them decide which account is best for their needs.

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