HSA or FSA? A Guide To Choosing The Best Option For Your Business
If you’re like many employers, providing employees with affordable healthcare benefits is top of mind. However, with employer healthcare costs expected to increase 6.5% in 2023, it’s critical the benefits you provide fit within your budget as well. Tax advantaged plans like Health Savings Accounts (HSAs) and Health Flexible Spending Accounts (FSAs) can be a cost-effective way to provide competitive benefits that will help attract and keep great talent while protecting your bottom line. Not sure whether an HSA or FSA is best for your business? Let’s find out.
In this article, we’ll look at how HSA and FSA plans compare in key areas like contribution limits, tax advantages, employer costs to help you understand how they compare against one another. After reading this, you’ll have a good idea of how these two options compare to each other and be able to choose the option that will help you recruit and retain employees.
HSA vs FSA: What’s the difference?
HSAs and FSAs are two of the most popular tax advantaged plan types. As you evaluate these options as an affordable way to offer more benefits that fit within your budget, you’ll want to compare the plans in several different areas.
For HSAs, one of the most important things to consider is that your employees are only eligible to participate if they’re covered under a qualifying high deductible health plan (HDHP), so you’ll have to sponsor one of these plans. Employees also can’t have any other health coverage. This means that they can’t be covered by a spouse’s plan, Medicare, or TRICARE. It’s important to note that employees with an HSA also can’t be claimed as a dependent on someone else’s tax return.
FSAs are offered in conjunction with your other employer-provided benefits, meaning, employees can’t get one on their own. Most employees are eligible to take part in an FSA. Unlike with an HSA, it doesn’t matter what type of health insurance plan they have – and in some cases, they don’t even need to have insurance to participate.
Any eligible individual can contribute to an HSA. You as the employer can also contribute to workers’ HSAs as well. If you offer an HSA through a cafeteria plan, employees may contribute with pre-tax payroll deductions and can also contribute after tax. One of the ways that an HSA and FSA differ is how flexible each plan type is when it comes to changing employee contribution amounts. HSAs allow employees to change the amount they contribute at any time during the plan year. However, only funds paid in to date can be accessed.
In contrast, employees need to designate how much they want to contribute to an FSA at the beginning of the year, usually through voluntary salary reduction agreements with you that allow them to elect an amount to be voluntarily withheld from their pay. This amount can only be adjusted based on a change in employment or family status. Depending on how you set up your plan, you as an employer may also contribute to your employees’ FSAs. Regardless of when the money is paid in, however, employees can access it at the start of the plan year.
The amount an employee or other person can contribute to an HSA depends on the type of HDHP coverage, the employee’s age, and the date they became eligible, with limits set by the IRS. For 2023, employees with coverage for themselves only can contribute up to $3,850. Those with family HDHP coverage can contribute up to $7,750. The contribution limit for employees is increased by $1,000 at the end of the tax year for those who are 55 or older. Both employee and employer contributions count towards these annual maximum amounts.
In the case of FSAs, the maximum amount an employee can contribute is set by the employer and subject to IRS regulations. For 2023, salary reduction contributions to a health FSA can’t be more than $3,050 a year (or any lower amount set by the plan).
As you decide whether to add either an HSA or FSA plan to your employee benefit offerings, you should understand the difference in how remaining balances are treated at the end of the year. With an HSA, the amounts that an employee has left over at year’s end are carried over to the next year.
On the other hand, FSAs are what’s known as “use-it-or-lose-it” plans. That means funds that aren’t spent by the end of the plan year are generally forfeited (and returned to the employer) and can’t be rolled over, forcing employees to think about how much they expect to spend on healthcare when they enroll. However, you as an employer can design a plan to provide either a grace period or a carryover.
5. Tax Savings
There are tax advantages for employers with both an HSA and FSA plan. Contributions are generally excluded from an employee’s income and aren’t subject to taxes so you won’t be responsible for the employer portion of Social Security and Medicare taxes on employee contributions. Plus, your contributions are tax deductible. But the plans also hold tax benefits for employees.
An HSA is one of the most tax advantaged health plans for several reasons:
- Employees can claim a tax deduction for contributions they, or someone else, makes to their HSA even if they don’t itemize deductions on your taxes.
- Contributions to an HSA made by an employer (including contributions made through a cafeteria plan) may be excluded from the employee’s gross income.
- The interest or other earnings grow tax free.
- Distributions may be tax free if employees pay qualified medical expenses.
FSAs also provide significant tax benefits as well, including:
- Contributions made by the employee or employer are excluded from the employee’s gross income so employees save on employment or federal income taxes, boosting their take-home pay.
- Reimbursements may be tax free if the employee uses the money to pay qualified medical expenses, which we’ll talk about next.
6. Healthcare Expenditures
With either an HSA or FSA plan, withdrawals are tax free if they’re used for qualified medical expenses. These are expenses that generally would qualify for the IRS’ medical and dental expenses deduction, which can be found in IRS Publication 502, Medical and Dental Expenses. Employees may have the option to use a debit card to pay for expenses or they may need to submit claim forms for reimbursement.
While both types of plans treat the use of funds for medical expenses the same, they differ in the ability to use the money for non-medical expenses. Specifically, FSA funds can’t be used for non-medical expenses. However, HSA funds can be, but the money will be taxable and subject to a 20% penalty for employees under 65 (those over 65 will still have to pay income tax on distributions for non-medical expenses).
7. Administrative Costs
Since these plans can be highly technical and have complex compliance requirements, most employers choose to outsource ongoing management to a third-party administrator (TPA) to alleviate this burden. The costs for an HSA vs an FSA are roughly the same.
For an HSA, a TPA will generally charge a one-time set up fee of anywhere between $150 and $1,500 and a per employee per month (PEPM) charge of $3 to $10.
With an FSA, you can likewise expect to pay about $150 to $1,500 to set up the plan, then an average of $5 PEPM fee.
An HSA is an employee-owned savings account and, in that sense, is “portable.” All funds, including those contributed by an employer, stay with workers even if they change employers or leave the workforce.
Employers, on the other hand, are the ones who own FSAs. They can’t be maintained when an employee no longer works for you so they’ll lose any unspent funds in their FSA when they leave.
Is an HSA or FSA a better fit for my business?
Whether you choose to offer an HSA or FSA, with either plan type, you’ll lower employees’ tax liability, enhance their satisfaction with your benefit offerings, and reduce your taxes as well.
However, as you decide between an HSA and FSA for your organization, it’s important to note that both options have advantages and disadvantages that may make one better suited for your business’ unique needs.
HSAs work well if you:
- Offer a qualified high deductible health plan
- Want to help employees save for the long-term as well, including in retirement
- Like the idea of giving employees more flexibility in how they use their funds
FSAs typically fit those who:
- Want to offer an account to any employee, regardless of what, if any, health plan they choose
- Look at the plans as a way to encourage retention
- Are willing to give employees complete access to their annual election even if it’s not funded
If you’d like more help in deciding on the best option for your organization, you may want to work with a TPA to make it as easy as possible to provide these benefits. Read our next article on the top factors to consider when evaluating TPAs.
Editor's Note: This blog was originally published in September of 2020 and was updated in January of 2023 for accuracy.