HSA or FSA? How each works, and how to budget for irregular medical costs

The short answer

• A health savings account (HSA) is an account you own. You can add money only for months when you are covered by an HSA-eligible health plan and have no disqualifying coverage. Unspent money stays yours year after year, can be invested, and goes with you when you change jobs.
• A health flexible spending arrangement (FSA) is an employer benefit that works with almost any health plan. You choose an amount before the plan year, and the full amount is available from day one. Money left at the end is generally lost, apart from a small carryover or short grace period if your plan offers one.
• Federal limits: for 2026, $4,400 (self-only coverage) or $8,750 (family coverage) for an HSA, and $3,400 for a health FSA. For 2027, the HSA limits are $4,500 and $9,000. As of October 21, 2026, the IRS had not announced the 2027 FSA limit.
• In California, HSAs get no state income tax break. Health FSAs do.
• To budget, add up the costs you can predict, add a cushion that stops at your plan's out-of-pocket maximum, subtract what you have set aside, and divide by the paychecks or months left.

This page covers health FSAs. Dependent care FSAs have separate rules.

The two accounts side by side

How an HSA works

Who can put money in

On the first day of each month, you must:

• be covered by an HSA-eligible health plan;
• have no other health coverage, except allowed types such as dental, vision, accident, disability, long-term care or telehealth coverage, or a policy that pays only for a specific disease or a fixed amount per hospital day;
• not be enrolled in Medicare; and
• not be someone else's tax dependent.

A spouse's non-HSA plan does not block you if it does not cover you. You can open an HSA through an employer or on your own with a bank, insurance company or other approved trustee.

Which plans count

High-deductible health plans (HDHPs) that meet IRS limits. They may still cover preventive care before the deductible.

The federal tax law signed July 4, 2025 (Public Law 119-21) widened eligibility:

• Bronze and catastrophic plans. From January 2026, a bronze or catastrophic plan available as individual coverage through a health insurance exchange counts as HSA-eligible, even if it misses the HDHP limits. In California, the exchange is Covered California. Catastrophic plans are open only to people under 30 or with a hardship or affordability exemption. Bronze plans small employers buy through the exchange's small-business program generally do not qualify this way.
• Telehealth. A plan can cover telehealth before the deductible without losing HSA status, permanently, for plan years beginning after December 31, 2024.
• Direct primary care. From January 2026, you can belong to a direct primary care practice and still contribute if the fixed membership fee is the only payment, the care is primary care from primary care clinicians, and fees total no more than $150 a month ($300 if more than one person is covered). The limits stay the same for 2027. The membership cannot include procedures needing general anesthesia, prescription drugs other than vaccines, or lab tests not usually done in a primary care office. You can pay the fees from your HSA, but they do not count toward your plan's deductible. If fees exceed the limit, the HSA can still pay them, but you cannot add money while you are a member.

How much and when

The yearly limit covers deposits from everyone, including your employer. If you are eligible for only part of the year, the limit is usually prorated by month. Under the last-month rule, if you are eligible on December 1 you may contribute the full year's amount, but you must then stay eligible through December 31 of the next year. If you do not, the extra amount becomes taxable plus a 10 percent additional tax, unless the reason is disability or death. You can generally contribute for a year until the federal filing deadline the next April.

Spending the money

• Withdrawals are tax-free for qualified medical expenses for you, your spouse or your tax dependents, incurred after you opened the HSA. You need not spend the money each year.
• Keep receipts showing each withdrawal paid a qualified expense that was not reimbursed elsewhere or deducted on a tax return.
• HSA money generally cannot pay premiums. Exceptions: COBRA, coverage while you receive unemployment benefits, long-term care insurance (up to age-based limits), and Medicare and other coverage from age 65, but not Medigap.
• Other uses are taxed as income plus a 20 percent additional tax, which does not apply after age 65, disability or death.

Medicare

Your contribution limit drops to zero from the first month you are enrolled in Medicare, including backdated months. If you sign up late and coverage starts retroactively, deposits for those months become excess contributions. Before enrolling, ask the Social Security Administration what your start date would be, and stop deposits in time.

How a health FSA works

• You choose once a year. Your employer takes the amount from each paycheck. Midyear changes are allowed only if the law and your plan permit.
• The full amount is available on day one. Elect $1,200 and you can be reimbursed up to $1,200 in week one. Expenses must happen during the plan year, you usually need a receipt, and the FSA cannot pay in advance for future costs.
• Use it or lose it. Leftover money is generally lost. Your plan may offer one of two options, not both: a carryover (for plan years beginning in 2026, up to $680 into the next plan year) or a grace period of up to two and a half months to spend leftovers.
• Claims deadline. Plans may allow a "run-out period" after the year ends to submit that year's claims. Your plan documents set the dates.
• Leaving your job. Unused money is generally lost unless you continue the FSA through COBRA.
• Limits. The federal limit is $3,400 for plan years beginning in 2026, and your employer may set less. The IRS had not published the 2027 figure as of October 21, 2026; check before you choose an amount for 2027.

Can you have both?

Usually not, with one exception.

• A general-purpose health FSA counts as other coverage, so it blocks HSA contributions. That includes a spouse's FSA if it can pay your bills.
• A limited-purpose FSA pays only for dental, vision and preventive care, and can sit alongside an HSA.
• Watch the switch. Moving from a general-purpose FSA to an HSA-eligible plan? A grace period at the start of the new year blocks HSA eligibility unless your old balance was zero at the end of the prior plan year. If your FSA has a carryover instead, ask whether leftovers can move to a limited-purpose FSA.

In California: the state tax difference

California does not recognize HSAs for state income tax. Its 2025 return instructions say:

• HSA contributions you deduct federally are not deductible on your California return.
• Employer and payroll contributions (box 12, code W, on your W-2) are added back to California income.
• Interest and other earnings inside the HSA are taxable by California in the year earned, and gains or losses from selling investments inside it go on the state return.
• A withdrawal that is federally taxable because it did not pay a medical expense is not taxable on your California return.

California's Employment Development Department also lists HSA contributions as wages for state payroll taxes, including State Disability Insurance; health FSA contributions through an employer's cafeteria plan are not. Bills to give HSAs a California tax break have failed several times, including Assembly Bill 781, which stalled in February 2026. Keep each year's HSA statements for your state return.

What the money can pay for

Both accounts follow the IRS definition of medical care. An FSA pays only what its plan document lists, so it may be narrower.

The over-the-counter rule is broader for HSAs and FSAs than for the itemized medical deduction on a tax return, where non-prescribed drugs other than insulin do not count.

Which account fits?

1. Is your plan HSA-eligible? If not, consider an FSA if offered, or a regular savings account.
2. Is a large cost coming early in the year, such as surgery or braces? An FSA pays up to your full election on day one. An HSA holds only what is deposited, though you can reimburse yourself later for a qualified cost you paid after opening it.
3. How predictable are your costs? Put only predictable costs in an FSA. An HSA can also hold a cushion, because unspent money is not lost.
4. Could you pay the deductible in month one? HSA-eligible plans often have higher deductibles. How to compare two health plans beyond the premium walks through the yearly math.
5. Does your employer add money? That lowers what you need to save.
6. Do you file in California? The HSA tax break is federal only.

How to budget for irregular medical costs

Medical bills come in lumps: a crown, new glasses, a specialist visit. A sinking fund, meaning money set aside a little at a time for a cost you expect, smooths them out.

1. Planned costs outside your plan's out-of-pocket maximum: dental, glasses, over-the-counter items, medical travel, services your plan does not cover.
2. Planned cost sharing for covered care: expected copays, coinsurance and deductible.
3. Cushion for unplanned covered care. Many people use their deductible.
4. Covered-care total = the smaller of (line 2 + line 3) and your in-network out-of-pocket maximum. Skip the cap if uninsured.
5. Yearly target = line 1 + line 4.
6. Money already set aside.
7. Employer contributions expected.
8. Still to save = line 5 − line 6 − line 7, or zero if negative.
9. Per paycheck or month = line 8 ÷ paychecks or months left, rounded up to the next dollar.

The printable irregular medical costs worksheet has blank lines and more examples, including a family whose costs reach the out-of-pocket cap.

Common mistakes

• Electing an FSA amount from hoped-for spending rather than costs you can name.
• Opening an HSA while a general-purpose FSA, yours or a spouse's, covers you.
• Forgetting that employer deposits count toward the HSA limit.
• Throwing away HSA receipts.
• Continuing HSA deposits into Medicare months, including backdated ones.

If a large bill arrives first, ask for an itemized bill, a payment plan and financial assistance; How to read an itemized hospital bill before you dispute it explains each step. For coverage changes ahead, see What changes for health coverage in 2027.

Questions to ask

• HR or benefits office: Is our plan HSA-eligible? When does the employer deposit? Does our FSA have a carryover or grace period, and when are claims due? Is a limited-purpose FSA offered?
• Your health plan: What are the in-network deductible and out-of-pocket maximum? Which services are covered before the deductible?
• A tax professional: How do proration and the last-month rule apply to me? In California, how do I report HSA contributions and earnings?

This page is general education, not tax, legal or financial advice. Plan documents and current IRS and Franchise Tax Board guidance control.

Sources

1. Revenue Procedure 2025-19: 2026 inflation-adjusted amounts for HSAs — Internal Revenue Service, accessed October 21, 2026.
2. Revenue Procedure 2026-24: 2027 inflation-adjusted amounts for HSAs — Internal Revenue Service, accessed October 21, 2026.
3. Revenue Procedure 2025-32: 2026 inflation adjustments, including the health FSA limit and carryover — Internal Revenue Service, accessed October 21, 2026.
4. Notice 2026-5: Expanded availability of health savings accounts under the One, Big, Beautiful Bill Act — Internal Revenue Service, accessed October 21, 2026.
5. Publication 969 (2025), Health Savings Accounts and Other Tax-Favored Health Plans — Internal Revenue Service, accessed October 21, 2026.
6. Publication 502 (2025), Medical and Dental Expenses — Internal Revenue Service, accessed October 21, 2026.
7. Notice 2013-71: Modification of the "use-or-lose" rule for health FSAs — Internal Revenue Service, accessed October 21, 2026.
8. IRS newsroom — Internal Revenue Service, checked October 21, 2026, for an announcement of 2027 FSA limits.
9. 2025 Instructions for Schedule CA (540) — California Franchise Tax Board, accessed October 21, 2026.
10. Bill analysis: AB 781, Health Savings Account deduction conformity — California Franchise Tax Board, analysis of the bill as amended March 28, 2025.
11. AB 781 (2025–2026) bill record — California Legislature (reproduced by CalMatters Digital Democracy), accessed October 21, 2026.
12. Information Sheet: Taxability of Employee Benefits (DE 231EB) — California Employment Development Department, revision 6-17, accessed October 21, 2026.
13. Explainer: Health Savings Accounts and Eligible Health Plans — California Health Benefits Review Program, University of California, August 2026.