Health Savings Account (HSA) vs. Flexible Spending Account (FSA): What to Know Before You Enroll

Healthcare is one of those expenses that can eat away at your money at any stage of life. Seniors are often advised to budget aggressively for their healthcare costs in retirement. But the reality is that whether you're 75 or 35, there's always a possibility that you'll soon find yourself with a massive pile of medical bills to tackle without much warning.

That's why it's so important to have a portion of your savings specifically earmarked for healthcare expenses. And if you're going to save for healthcare, you might as well do so in a tax-advantaged manner.

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To that end, you have a couple of choices. You could open a flexible spending account (FSA), or you could put money into a health savings account (HSA).

FSAs and HSAs are similar in that they're both healthcare savings accounts that you fund with pre-tax dollars. Withdrawals from both accounts are also tax-free, provided you use the money for qualifying medical expenses.

But there are a couple of key differences between FSAs and HSAs you should know about. And it's important to have all the right information before deciding to open one or the other, since you can generally only have one at a time.

HSAs let you invest money you aren't using

One big advantage HSAs have over FSAs is that they let you invest the money in them that you aren't using, giving it the opportunity to grow into a larger sum. With an FSA, there's no option to invest the money that's sitting in your account unused. But there's a big reason for that.

HSAs let you carry your money forward

The reason you can't invest your FSA funds is that these accounts force you to use up your balance by the end of your plan year. If you don't, you risk forfeiting the remaining money. Some FSAs do have grace periods that give you a little extra time to use up your balance. But for the most part, when you fund an FSA, you're setting aside money for the upcoming year only.

HSAs, on the other hand, let you carry the money you deposit in them forward indefinitely. In fact, one good way to take advantage of an HSA is to contribute to it regularly, but pay for whatever healthcare expenses you have out of pocket over the years, and leave your balance alone and invested until you reach retirement age. That will give your money more time to grow.

Not only do HSAs let you carry a balance into retirement, but once you turn 65, you can use HSA funds for any purpose without incurring a penalty. Now, if a withdrawal is not for qualifying medical expenses, it will be taxable. But that's no different than a withdrawal from a traditional IRA or 401(k) plan.

HSAs are only compatible with certain health insurance plans

One benefit of FSAs is that if your employer offers one, you can opt to participate regardless of the type of health insurance plan you're enrolled in. With an HSA, your health insurance plan needs to meet certain criteria regarding your deductible and out-of-pocket maximum. Those criteria are adjusted by the government every year.

In a nutshell, though, HSAs are only compatible with high-deductible insurance plans. If your plan doesn't qualify, you won't be able to sign up for an HSA. However, it's important to check your eligibility every year, since your plan's deductible can change, and the rules for these accounts can change as well.

Both FSAs and HSAs give you an opportunity to save some money on taxes while setting money aside for expenses that, when they arise, are largely unavoidable. It's important to understand how these accounts work and how they differ from each other so you can pick the one that's best for you. But ultimately, that choice may boil down to which health insurance plan you've chosen to enroll in and whether it's compatible with an HSA or not.

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