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Understanding Health Savings Accounts (HSAs) and Health Spending Accounts (FSAs)

A Health Savings Account (HSA) and a Flexible Spending Account (FSA) are two different ways to set aside money for healthcare costs before taxes are taken out of your paycheck. The key difference comes down to how long you can keep the money and what happens to it if you don't spend it.

An HSA is a savings account you can open if you have a high-deductible health insurance plan. According to the IRS, in 2024, a high-deductible plan for individual coverage has a deductible of at least $1,600, and for family coverage, at least $3,200. With an HSA, you contribute money from your paycheck before taxes are taken out. The money rolls over year to year—you never lose it. If you don't spend it one year, it stays in your account earning interest or investment returns. You can use HSA money to pay for qualified medical expenses, and after age 65, you can withdraw money for any reason, though non-medical withdrawals before 65 come with a 20% penalty plus taxes.

An FSA works differently. You set aside money from your paycheck before taxes, but you typically must spend it within the plan year or you lose it. Some plans allow a small carryover amount (usually up to $640 in 2024) or a two-month grace period, but the "use-it-or-lose-it" rule generally applies. FSAs are offered through your employer and don't require a high-deductible health plan.

Practical takeaway: If you want money that stays with you long-term and grows, an HSA may work better. If you want to reduce your taxes on predictable medical costs you'll definitely spend each year, an FSA may be the right choice.

Who Can Open an HSA and What Are the Rules

Not everyone can open an HSA. You must meet specific requirements to open and contribute to one. First, you need to be enrolled in a high-deductible health plan (HDHP). Second, you cannot be covered by any other health insurance that is not an HDHP—with limited exceptions for accident, disability, dental, vision, or long-term care coverage. Third, you cannot be claimed as a dependent on someone else's tax return. Fourth, you cannot be enrolled in Medicare.

If you meet these requirements, you can open an HSA through a bank, insurance company, or financial institution. You don't need your employer to sponsor it, though many employers do offer HSAs as part of their benefits packages. The IRS sets contribution limits each year. For 2024, you can contribute up to $4,150 if you have individual coverage or $8,300 if you have family coverage. If you're 55 or older, you can add an extra $1,000 per year (called a catch-up contribution). These contributions reduce your taxable income, which means you pay less in federal income taxes.

Money in an HSA can be invested in stocks, bonds, or mutual funds through many HSA providers, allowing it to grow over time. You can withdraw money tax-free for any qualified medical expense. The IRS maintains a long list of what counts as a qualified expense—it includes copays, deductibles, prescription drugs, doctor visits, dental work, vision care, and many other healthcare costs. It does not cover cosmetic surgery, health club memberships, or over-the-counter medications (with some exceptions for items like pain relievers).

Practical takeaway: Before opening an HSA, verify that your health plan is truly a high-deductible plan and that you have no other health coverage that would disqualify you. Check the IRS website or speak with your plan administrator to confirm your requirements.

How FSAs Work and What You Need to Know

An FSA is typically set up through your employer's benefits program. During your company's open enrollment period—usually once a year—you decide how much money to put into your FSA for the coming year. The money comes from your paycheck before taxes, which reduces your taxable income. For 2024, the maximum contribution to an FSA is $3,300 per year. This money sits in an account, and you use it to pay for eligible medical expenses throughout the year.

The critical rule with FSAs is the use-it-or-lose-it principle. If you don't spend the money by the end of the plan year, you forfeit it. However, the rules have become slightly more flexible in recent years. Many employers now allow a carryover of up to $640 into the next plan year, and some offer a two-month grace period after the plan year ends to spend remaining funds. Before you enroll, check with your employer to see which option (if any) they offer.

You can use FSA money to pay for many of the same medical expenses as an HSA—copays, deductibles, prescription drugs, dental care, vision care, and more. You typically receive a debit card or submit receipts for reimbursement. Some employers require you to provide documentation proving the expense was medical in nature. Because you don't know exactly what medical expenses you'll have during the year, experts recommend estimating conservatively. If you estimate too high and can't spend the money, you lose it (except for any carryover amount).

Practical takeaway: When enrolling in an FSA, think carefully about what medical expenses you know you'll have—prescriptions, regular doctor visits, dental cleanings. Don't overestimate; it's better to contribute less and not lose money than to contribute too much and watch unused funds disappear.

Tax Savings and Financial Benefits Explained

The main financial benefit of both HSAs and FSAs is the tax savings. When you contribute to either account, that money comes out of your paycheck before federal income tax, state income tax (in most states), and payroll taxes (Social Security and Medicare) are calculated. This is called a pre-tax deduction, and it reduces the amount of income you're taxed on.

Here's a concrete example: Suppose you earn $50,000 per year and normally pay about $5,000 in federal income tax. If you contribute $2,400 to an FSA during the year, your taxable income drops to $47,600. Your federal income tax might drop to about $4,680. You've saved roughly $320 in federal taxes alone. Add in state and payroll taxes, and your total savings could exceed $500. That's money you keep because you're paying for medical expenses you'd have to pay for anyway—but now you're doing it with pre-tax dollars.

With an HSA, the tax benefits are even more generous over time. Not only are your contributions tax-deductible, but the money grows tax-free if you invest it, and withdrawals for qualified medical expenses are tax-free. The IRS calls this a "triple tax advantage." If you contribute $4,150 to an HSA in 2024, invest it, and it grows to $6,000 by the time you need it for medical expenses, you pay no taxes on that $1,850 in growth. With an FSA, any growth is minimal because the money is meant to be spent within the year.

The Department of Health and Human Services estimates that the average American family spends between $1,000 and $2,000 per year on out-of-pocket medical expenses. By using an HSA or FSA, families can reduce their taxable income and their overall tax bill while paying for those necessary expenses.

Practical takeaway: Calculate your estimated annual medical expenses (including copays, deductibles, medications, and routine care). Then estimate your tax rate. Multiply the two numbers to see roughly how much you could save in taxes by using an HSA or FSA.

What Expenses Qualify and Common Mistakes to Avoid

Both HSAs and FSAs can be used for a wide range of medical expenses, but not everything healthcare-related qualifies. Understanding what counts and what doesn't can prevent you from accidentally spending account money on non-qualifying expenses and facing penalties.

Qualifying expenses include: doctor visits and copays, hospital services, prescription drugs, dental cleanings and procedures, vision exams and eyeglasses, contact lenses and solution, hearing aids and batteries, mental health counseling, physical therapy, chiropractic