Health Savings or Flexible Spending Account?

Healthcare can be costly even for the heartiest among us. Even if you have insurance through your employer, you might consider taking advantage of one of the federal government programs that encourage saving for medical expenses not covered by insurance. The tax benefits can be substantial.

The two types of accounts most often offered to employees are the Health Savings Account (HSA) and the Flexible Spending Account (FSA). Self-employed people can open an HSA but not an FSA.

SEE: Fighting The High Costs Of Healthcare

An HSA is offered by employers in conjunction with a high deductible health insurance policy. Self-employed people who have high deductible plans also can set up HSA accounts.

The employer or self-employed individual deposits all or a portion of the deductible into an HSA to cover costs until the deductible is met and the health insurance policy takes over the financial burden.

Once the account is set up, an employee can contribute additional money to the HSA via a payroll deduction from gross income. The money contributed to an HSA account is tax deductible. Interest or earnings on the money in the account is tax-free. Withdrawals used to pay for qualified medical expenses are tax-free too.

A withdrawal from an HSA can be used for a broad range of medical expenses including eyeglasses, contacts, chiropractic care and prescription drugs as well as doctor visits and hospital stays.

Finally, the HSA is a portable account so you keep your money even if you switch jobs.

In order to qualify for an HSA, you have to be enrolled in a high-deductible health plan. In most cases, you are not eligible if you have other health coverage or can be claimed as a dependent by someone else.

A flexible spending account (FSA) is similar to an HSA, but there are a few key differences. For one, self-employed individuals aren't eligible.

The biggest benefit of the FSA is that withdrawals can be made for child care expenses as well as medical expenses. 

Like the HSA, you can contribute to an FSA using your gross pay, making the contributions tax free. As long as you use the funds to pay for qualified medical expenses, you probably won't owe taxes on withdrawals.

Unlike an HSA, you have to declare how much you would like your employer to deduct from your gross pay in order to fund your FSA in each calendar year. Once that declaration is made, you generally can't change it. If you declined the FSA during the open enrollment period, you probably have to wait until the next open enrollment.

Your declared funds must be spent within the tax year, although a grace period is sometimes granted until the tax filing deadline. The money you contribute can be lost if you don't spend it by all by the deadline.

You don't have to be covered under a health insurance policy to be eligible, but FSA funds are not an adequate substitute for health insurance. If you can't afford both, it would be better to put those funds towards health insurance.

The table below shows the differences and similarities between both health accounts:

An HSA is a better choice for most because the funds roll over to the next year. The interest on your contributions is tax-free. If you are enrolled in a high deductible health plan, you will automatically be enrolled in an HSA, making it an easy choice.

SEE: 5 Things To Know About Managing Your Healthcare Deductible

Still, many companies offer both plans. For people who have children in daycare, an FSA can represent an annual savings of more than $1,000. Just keep an eye on the account to make sure you don't let any accrued money expire at the end of the year.