FSA and HSA plans for small business: what’s the difference?

What is an FSA?

FSAs — or flexible spending accounts — allow employees to set aside a portion of their pre-tax wages to pay for qualified expenses. At the same time, FSA contributions lower an employees’ taxable income, as well as the FICA taxes — and Medicare taxes — you’re responsible for as the employer. In other words, establishing FSA programs can be a win-win. While there are a few different types of FSA plans out there, the most common is the Health Care FSA (HCFSA).

What is a Health Care FSA and how does it work?

A Health Care FSA is used to pay for eligible medical-related expenses such as pharmacy, dental, and vision fees, as defined in Publication 502 from the Internal Revenue Service (IRS).  Employees are able to choose how much they want to contribute, up to a maximum of $3,200 for 2024. As the employer, you are the owner of the account and will pre-fund the amount of the employee’s entire FSA election at the start of the year. But employees have to enroll into an FSA — some people opt not to contribute.

When establishing HCFSAs, it’s important to encourage employees to contribute only the amount they think they will spend in a given year because — in most cases — money in this type of account does not roll over into the next calendar year, if it hasn’t been spent. Employees should view the money in the account as “use it or lose it” cash. Although, there’s a few ways to soften this limitation:

• Offer a grace period, which allows employees an extra two and a half months to spend their contributions.
• Establish a plan that allows employees to carry over as much as $640 in unused funds into the next year.

While you do have the option of implementing a grace period or allowing carry-over, you cannot do both. Additionally, it’s important to note that you’re not required to offer either option. If you do choose to add one of these options to your plan, give it some thought — and consider polling your employees — to determine which one may be a better fit.

It’s also a good idea to educate employees about some of the alternative ways the money in an HCFSA can be spent to help prevent the funds from going to waste; there’s many items employees can purchase with proper planning. For example, employees can use their HCFSA dollars to cover copays and coinsurance — or expenses that an employee may not have insurance to cover, such as vision care, glasses, or contact lenses.

Additional eligible ways to spend the funds can include:

• Purchasing items from fsastore.com (this site makes it easy to shop for what’s available to purchase)
• Covering costs of travel for medical care
• Acupuncture and chiropractor visits
• Mental health and drug abuse counseling
• Birth control
• Artificial teeth or limbs
• Qualified service animals, such as a guide dog, including food and grooming
• Diabetic supplies
• First-aid supplies such as bandaids
• Sunscreen of SPF 15 or higher
• Medical conference attendance costs, for conferences related to an illness that impacts the employee, their spouse or primary dependent.
• Vehicle modification to make a vehicle accessible for someone with a disability
• Medical remodeling if renovations are needed in an employee’s home to accommodate disabilities

Keep in mind that there is some risk to the employer when offering an FSA. For example, an employee can elect to contribute the full $3,200 to their FSA account. However, should they choose to spend the full amount in the first two months of the year and then leave your company, you would lose the difference between what you pre-funded and the amount of money the employee contributed before leaving. In such cases, the employee is not responsible for making contributions after leaving the job.

On the flipside, there is a risk to employees as well. Any FSA funds that haven’t been used by the end of the plan year are defaulted to the employer and are no longer available to the employee. This can result in a serious blow to employee morale. Communication is key to avoid such challenges: an employer’s best course of action is to communicate regularly, reminding employees to use their available funds as the year comes to an end.

What about a dependent care FSA?

A dependent care FSA covers the costs of preschool, summer day camp, before or after school programs, and child or adult daycare.

These are quite common and work similarly to an individual FSA plan, but with a higher contribution limit to cover your employees’ dependents. The contribution limit for a dependent care FSA plan is $5,000 per family in 2024 (unchanged from 2023) and $2,500 if married, filing separately. This means if you offer a dependent care FSA, both parents cannot have this plan if the total contributions add up to more than $5,000. Employees can have both a regular FSA and a dependent FSA, but can only use the funds in the dependent plan to cover expenses to care for their dependents.

What is an HSA?

Similar to FSAs, an HSA will lower your employees’ taxable income. As yet another type of medical savings bank account, your employees are able to contribute money from each paycheck to an HSA with pre-tax dollars. And again, this process lowers the amount of FICA taxes and Medicare you are responsible for matching as the employer. Unlike an FSA account, however, HSAs are owned completely by the employee, so they can be transferred from one job to another.

The major caveat to having an HSA account is it can only be obtained by people who have an HSA-qualified medical plan. HSA-qualified medical plans are insurance plans where the premiums (monthly costs) are lower, the deductibles (the amount participant’s pay before insurance kicks in) are higher. A plan is considered an HSA-qualified plan if the employee’s deductible is at least $1,650 for individual coverage or $2,800 for family coverage.

In 2024, the contribution limit for HSA bank accounts is $4,150 for an individual, while the limit for families is $8,300. And unlike FSA plans, funds not spent in an HSA plan do carry over into the following year. In addition, the funds that are carried over will not count towards the contribution limit in the new year.

What is an LPFSA?

For companies that do not offer high deductible health plans, only one of the accounts we’ve talked about in this article can actually be offered to your employees. That’s the FSA or flexible spending account.

But, if you do offer a high deductible health plan, you have the option of also offering employees an HSA or HSA along with what’s known as a Limited Purpose Flexible Spending Account or LPFSA. If you’re not familiar with a LPFSA, they are pre-tax contribution accounts that are designed to work in conjunction with high deductible health plans.

Employees can use the money contributed to LPFSAs to pay for out-of-pocket expenses for eligible dental, vision care and even post-deductible medical costs. In other words, an LPFSA helps employees offset the high deductible of their insurance plan. The money can be used to pay for eligible expenses incurred by the employee, their spouse and qualified dependents.

We’ve covered a lot of ground. To make it easier to differentiate the different types of accounts, here’s a quick rundown of the key points: