The Triple Tax Advantage: Why HSAs May Outshine FSAs for Savers

Healthcare is one of those expenses that tends to creep up at any age. That's why it's important to have savings available for it at all times.

To that end, you may have a choice of a health savings account (HSA) or an FSA (flexible spending account). Both accounts offer tax advantages. But HSAs are a pretty clear winner for a few big reasons.

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Even more tax breaks

HSAs and FSAs offer healthcare savers a tax break on their money. In both accounts, contributions are made on a pre-tax basis, and withdrawals are tax-free as long as they're used to pay for qualifying medical expenses.

But HSAs have a big advantage over FSAs in that they allow you to invest the money you aren't using right away. Plus, investment gains in an HSA are yours to enjoy tax-free.

One common HSA strategy is to reserve the money for retirement, when your healthcare needs may be highest. If so, that means you might enjoy tax-free growth in your account for many years.

More flexibility

Don't let the name fool you -- FSAs are not as flexible as they might seem. FSAs typically force you to use up your funds by the end of each plan year or otherwise forfeit them. HSAs, on the other hand, reward you financially for not using up your balance each year.

HSA funds never expire, so you have the option to reserve the money for a period of life when you expect higher healthcare bills. For example, if you're planning to have surgery in your 50s, there may be associated expenses an HSA can help you cover. Being able to plan ahead is key.

Plus, many people end up seeing their healthcare costs rise during retirement. This can be due not only to aging, but to the fact that Medicare comes with a lot of out-of-pocket costs.

Having HSA funds available to you during retirement could help alleviate a lot of financial stress. That extra money could also help you avoid straining your nest egg if there's a year when you end up with unusually high bills.

Penalty-free withdrawals down the line

With an FSA, you typically cannot use your account for purchases that aren't medical in nature. And if you're able to use your money for a nonmedical expense, you'll generally have to repay your plan or face taxes on that money.

HSAs impose a 20% penalty on nonmedical withdrawals. But that penalty goes away completely once you turn 65.

What this means is that come age 65, an HSA can double as a backup IRA or 401(k) plan. Traditional IRA and 401(k) withdrawals are taxable in retirement. And the same holds true for HSA withdrawals taken at 65 or later for nonhealthcare purposes.

But at least you don't have to worry about a penalty in that situation. And unlike traditional IRAs and 401(k)s, with an HSA, you do not have to worry about required minimum distributions.

It pays to favor an HSA

While both FSAs and HSAs have their benefits, it pays to choose an HSA if you qualify for one based on your health insurance plan. That means being enrolled in a plan with a high deductible, the definition of which changes every year.

Though FSAs offer a nice tax break, HSAs go a step further by allowing for tax-free investment gains. Plus, they're more flexible on a whole.

If you're not eligible for an HSA, an FSA is still a pretty good option, provided you estimate your healthcare costs carefully to avoid winding up with extra money you can't use. But it's a good idea to check your HSA eligibility every year, since your insurance might change or the rules might change.

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