April 22, 2024

HSAs vs. FSAs: What to Consider for Retirement?

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If you’ve ever opted for a health plan through your employer, you may have been offered a tax-advantaged health savings account. The two most common types are Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs).

Here, we’ll break down the differences between these two accounts and discuss which one is generally more appropriate for some folks for long-term health savings and retirement.

What is an HSA, and How Does it Work?

A Health Savings Account (HSA) is a tax-exempt trust or custodial account designed to help eligible individuals with high-deductible health plans (HDHPs) set aside money on a pre-tax basis to pay for unexpected qualified medical expenses. The idea is that people who typically do not frequently visit the doctor can spend less on their health insurance premium payments by opting for an HDHP instead of a lower-deductible plan, and potentially contribute the difference — or more — to their HSA instead.

As long as you’re an eligible individual that is enrolled in a qualified HDHP (an HDHP that meets certain requirements regarding deductibles and out-of-pocket expenses for the year), either through a plan purchased via the health insurance marketplace (including as your own business) or through an employer, you typically can make pre-tax contributions to an HSA in whatever amounts and at whatever cadence works best for you, up to a predetermined annual maximum that is set each year. The funds in these tax-exempt accounts can be used to pay for a variety of qualified medical expenses (which will be outlined in the applicable HSA policies), including deductibles, copayments, coinsurance and certain other out-of-pocket healthcare expenses. A surprising amount of things can be HSA-eligible depending on your particular plan, including some fun items like massage guns and certain skin care products!

Additionally, you may be able to invest your HSA funds. Any earnings are also tax-free, making your HSA a potentially powerful investment vehicle. Another key benefit of an HSA is that the money in the account rolls over year after year, so it can accumulate and be used for future medical costs.

Because your HSA funds belong to you, not an employer, they are considered portable funds and can be used for eligible medical expenses even if you change jobs or leave the workforce entirely. And after age 65, you can actually use your HSA funds for non-qualified expenses, but withdrawals that aren’t for qualified medical expenses will be subject to ordinary income taxes. If you use your HSA funds on non-qualified expenses before age 65, then the amount you withdraw will be subject to income tax and may be subject to an additional tax.

Overall, HSAs can offer individuals with HDHPs a way to set aside money on healthcare costs, while providing tax advantages. However, if you frequently visit the doctor and know you will likely meet your deductible each year, a traditional, lower-deductible health insurance plan may save you money in the long term, so make sure you run the numbers if you’re considering switching to an HDHP during your next enrollment period.

What is an FSA, and How Does it Work?

A Flexible Spending Account (FSA) is an employer-established benefit plan that allows employees to set aside pre-tax dollars in the account to cover qualified medical expenses. Unlike HSAs, you do not have to be enrolled in an HDHP to be eligible to contribute to an FSA. However, FSAs are generally subject to a “use it or lose it” rule, meaning any funds left unused at the end of the plan year may be forfeited.

Like HSAs, FSAs can typically be used to pay for a wide range of qualified healthcare expenses depending upon your particular plan, including copayments, deductibles, prescriptions and certain medical supplies. Some FSAs also cover expenses such as vision and dental care.

Generally speaking, contributing funds to an FSA that you are already planning to spend on upcoming healthcare costs can have the effect of reducing your federal income tax liability. As the funds do not roll over to subsequent years, FSAs do not have the capacity to become a long-term investment tool like an HSA. However, since they can be paired with low-deductible health plans, they can potentially be a great option for individuals who more frequently visit the doctor and have somewhat predictable healthcare expenses.

During each open enrollment period, employees elect the amount they want to contribute to their FSA that year, and regular contributions are deducted from their paychecks to meet that amount, up to a maximum of $3,200 for individuals per year per employer (as of the date of publication).

Consider Whether an HSA May Be a Better Fit When Planning Long-Term for Retirement

You should carefully consider your individual healthcare needs, financial situation and eligibility requirements if you’re factoring a health savings account or flexible spending account into your retirement plan. An HSA may not be right for everyone. If you visit doctors a lot, an FSA paired with a lower-deductible plan may save you more on healthcare expenses in the long run. If you’re approaching retirement quickly and have yet to contribute to an HSA, it may be more beneficial for you to utilize other investment tools. Consider working with a trusted financial advisor to receive personalized guidance for your unique financial situation.

When planning for retirement, some individuals find that an HSA tends to offer more long-term benefits when compared with an FSA. Here's why:

Triple Tax Advantages: Contributions to both HSAs and FSAs are made with pre-tax dollars, but with an HSA, your investment earnings over the years are tax-free, and so are your withdrawals for qualified medical expenses [ECS2] . In retirement, when healthcare costs generally tend to increase, this can be particularly helpful, since having tax-free withdrawals may be able to help stretch your savings further.

Portability and Rollover: As previously mentioned, HSAs are portable accounts, meaning you can take them with you when you retire or leave a job. If unused, your HSA funds also roll over year after year and continue to grow tax-free, providing an opportunity to potentially accumulate a higher balance over time.

Investment Options: Some HSAs offer investment options once the account reaches a certain threshold. This means, depending on your account, you can potentially grow your HSA funds even further through investments in stocks, bonds or mutual funds. This is an option many retirees particularly love if they’ve been contributing to an HSA for a long time.

New, Increased Limits for Older Adults: The individual contribution limit for an HSA in 2024 is $4,150 per year. But if you’re 55 or older at the end of the tax year, you may be eligible to make an additional contribution of $1,000. This extra allowance for adults 55 and over is sometimes referred to as the “catch-up contribution.”

Flexible Spending Over Age 65: After you reach 65, you can withdraw your HSA funds for both qualified medical expenses and other reasons without incurring a penalty. Just keep in mind that withdrawals for non-qualified medical expenses will be taxed.

Ultimately, both HSAs and FSAs offer flexibility and tax advantages and the best option for you will depend upon your health and circumstances. You should consider talking to your employer or other benefits administrator to learn more about what, if any, HSAs or FSAs are offered.

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