What is the benefit of using a health savings account HSA or flexible savings account FSA quizlet?

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Both a healthcare flexible spending account (FSA) and a health savings account (HSA) can cut your taxes and help you save money on medical, dental, vision and other qualified medical expenses. And while they are alike in some ways, each offers different features and benefits.

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Here is what you need to know about an FSA and an HSA and how to determine which one may work best for you.

What Is a Flexible Spending Account (FSA)?

An FSA is a great tax savings tool to effectively pay for qualified out-of-pocket healthcare expenses. It is a tax-advantaged savings account established by your employer that allows you to stash money away for yourself, your spouse or dependents.

For starters, since you can only establish an FSA with your employer, it means your employer owns your FSA account. If you separate from your job, you would forfeit your FSA funds. For 2021, you can contribute up to $2,750 into a healthcare FSA and your employer may also contribute on your behalf. However, the IRS does not require your employer to do so.

Advantages of an FSA

One great advantage about an FSA is that your funds are immediately made available the day you enroll. For example, if you decide on Jan. 1 to contribute $2,400 annually with monthly pretax contributions of $200, you will have access to the entire $2,400 at the start of the year. This means if you have a qualified medical expense of $1,500 but your FSA account does not have the entire funds to cover it, your FSA administrator will still pay the entire claim.

And while that is great news, there are some disadvantages to an FSA.

Disadvantages of an FSA

The primary disadvantage is that, typically, most FSA accounts have a “use or lose it” feature, which means you need to spend all of your FSA funds before the end of the plan’s year. If you fail to do so, you will forfeit your FSA funds. Some employers may elect one of two features that can provide some flexibility with unused funds. These features include an extended grace period or a rollover provision.

An extended grace period allows you an additional 2.5 months to spend your FSA funds. If your employer has this feature, you will have until March 15 of the following year to spend your FSA funds. This deadline may differ if your employer’s administrator plan does not follow a calendar year; instead, you will have an additional 2.5 months following the plan’s year-end date.

In December 2020, then-President Donald Trump signed the Consolidated Appropriations Act of 2021 into law, which allows employers to alter their current FSA plans. These changes may:

• Allow you to carry over unused funds—in excess of the usual $550 limit—from both the 2020 and 2021 plan years to the next year, or
• Extend the grace period to up to 12 months after the plan year for both the 2020 and 2021 plan years

What Is a Health Savings Account (HSA)?

Similar to an FSA, an HSA also allows you to stash money away into a pretax account but works a little differently. Unlike an FSA, to contribute to an HSA you must qualify and meet the following requirements:

• You are not claimed as a dependent on anyone else’s tax return.
• You are not enrolled in Medicare.
• You are covered under a high deductible health plan (HDHP).

An HDHP is any healthcare insurance plan with a high deductible amount. For 2021, the minimum deductible amount for an individual HDHP is $1,400 and $2,800 for a family plan. Unlike an FSA, you own your HSA account and therefore it is portable, which means that if you separate from your employer, you can take your HSA funds with you.

You can also establish an HSA either independently or with your employer. If you have an employer-sponsored HSA account, the amounts you contribute are not subject to payroll or income taxes. However, if you set up your HSA account on your own, you can deduct your HSA contributions on your federal income tax return. You qualify for the tax deduction whether you elect to itemize your deductions or not.

But keep in mind, the IRS limits the amount you can contribute to an HSA.

2021 Contribution Limits

For 2021, you can contribute up to $3,600 if you have self-only HDHP coverage ($7,200 for family HDHP coverage). These limits include both employee and employer contributions. The IRS allows you more time to contribute to an HSA account than an FSA account. You or your employer can contribute in the current plan year or up to the due date of your tax return. For example, you can make 2021 HSA contributions until April 15, 2022, which is the tax deadline for your federal tax return.

Unlike FSAs, where you have a restriction on the time you can use your funds or a limited amount to roll over, an HSA is different. In the event you do not use your funds before the end of your plan year, you will not lose them. Your unused HSA funds are eligible to roll over each year without any limitations or restrictions.

Investing and Using HSA Funds

Another key difference between an FSA and an HSA is the ability to invest your HSA funds. Most HSA plans require a minimum balance to invest your HSA funds, which varies from employer to employer. Your HSA plan may offer different investment options, which may include stocks or bonds. Funds within your HSA account grow tax-free, therefore you do not have to pay taxes on your distributions if you use them for qualified medical expenses.

If you do not use your HSA funds for qualified medical expenses, it is subject to an additional tax of 20%. You are required to report any distributions not used for medical expenses on Form 8889 with your federal income tax return. However, there are a few exceptions to this rule. The IRS will not assess the additional penalty if you are 65 years of age, disabled or the distribution is made due to the death of the HSA holder.

The Key Differences Between an HSA and FSA

While a healthcare flexible spending account and a health savings account both allow you to set up tax-advantaged savings to pay for qualified medical expenses, there are some significant differences between the two. Here is a breakdown of how an FSA and HSA differ.

How to Choose Between an FSA and HSA

While both an FSA and HSA can help save you money on qualified medical expenses, you should take time to determine which account may work best for you. In particular, here are a few questions you should ask yourself before making a selection:

• Does my employer offer an FSA or HSA account?
• How much do I plan to spend on qualified medical expenses this year for myself, dependents or spouse?
• Do I desire a portable account outside my employer?
• Does my insurance plan qualify me to set up an HSA account?
• Do I want to invest my funds to allow my money to grow?

These are just a few items you should consider before selecting an FSA or HSA. FSAs are less flexible than HSAs. With an FSA, you may lose your money if you do not use it within a certain time frame, you can only establish it through an employer and, if you separate from your employer, the account is not portable.

An HSA account provides a bit more flexibility, in that your funds can roll over from year to year, your account is portable from job to job and you can invest your money, while it grows tax-free. But it is important to take a good look at both accounts to determine which you may qualify for and which works best for your medical needs.

Bottom Line

Both a healthcare FSA and an HSA can help you pay out-of-pocket qualified medical expenses. Because your contributions are made on a pretax basis, a healthcare FSA directly reduces your taxable income, as well as the payroll taxes you pay. When you have a high deductible medical plan at work, an HSA can be critical for filling in the expense gap that comes along with it. The funds in an HSA carry over from year to year, are yours if you leave your employer and can be invested.

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