Health Savings Account (HSA) or Healthcare Flexible Savings Account (FSA)?

November is open enrollment season, and many physicians and residents are mulling over their health insurance options for the upcoming year.

One of the major decisions employees have to make is selecting either a high-deductible health plan or a more traditional healthcare plan.

The high-deductible healthcare plan typically offers lower premiums and gives access to a health savings account (HSA). A more traditional healthcare plan will have higher premiums, but likely a lower deductible and more health coverage. It will also offer access to a healthcare flexible savings account (FSA).

Here’s an overview of the Healthcare FSA and HSA accounts, as well as some things to consider when choosing your health insurance this year.

Healthcare Flexible Savings Account (FSA) Overview

• Contributions are made during open enrollment (maximum is $2,500 per employee).
• Once the contribution amount is selected, it cannot be changed unless a qualifying life event occurs (such as getting married or having a baby).
• The money is generally “use it or lose it”, but some employers allow some carryover from one year to the next, or have grace periods.
• The full amount can be accessed on January 1st, even though the money will be deducted over the course of the year.
• Contributions are exempt from federal, state, and payroll taxes, but cannot be spent for any other purpose other than qualifying healthcare expenses.

Health Savings Accounts (HSA) Overview

• HSA contributions are only permitted if enrolled in a high-deductible health care plan (maximum HSA contribution is $3,450 for singles, $6,900 for married filing jointly in 2018)
• Employers may contribute money into the HSA on the employee’s behalf
• HSA money can be invested in mutual funds or other investments like a 401(k)
• There is no “use it or lose it” provision with HSAs
• HSA contributions are exempt from federal, state, and payroll taxes
• Withdrawals from HSA are tax-free if used for eligible healthcare expenses
• After the age of 65, HSA money can be withdrawn for any reason and taxed as ordinary income.
• You cannot contribute to an FSA if contributing to an HSA.

Choosing between Traditional or High-Deductible Health Insurance Plans

Current healthcare expenses

The first step when deciding between any two healthcare plans is your anticipated healthcare expenses for the upcoming year. The easiest way to do this is to simply look at your costs from this year or last year. If you were spending a lot on healthcare because you have a chronic illness that requires expensive medications, then you’d probably want a traditional healthcare plan.

On the other hand, if you are very healthy and spent nothing on healthcare last year, then an HSA is usually your best option. You minimize your insurance premiums, potentially subsidized by your employer through an HSA contribution, and have access to an HSA, which can be used to subsidize future healthcare costs.

One of the added benefits of choosing a high-deductible health insurance plan (HDHP) is the long-term tax benefits of contributing to an HSA. There are some scenarios where you may be paying more out-of-pocket for healthcare in an HDHP, but make up for this difference with the tax benefits of contributing to an HSA.

Ability to pay for out-of-pocket medical expenses

Some physicians, especially residents, are fearful of the possibility, however remote, that a car accident or other serious illness will lead to a huge hospital bill. Because they fear being hit with a healthcare bill of potentially $10,000 or more for an unplanned surgery or hospitalization, they will be willing to pay more for a traditional health insurance plan with lower deductibles and out-of-pocket maximums, even if an HSA would be financially optimal.

Estimating The Optimal Healthcare FSA Contribution

If you select a traditional health insurance plan, the next decision is whether to contribute to an FSA and if so, how much.

Again, you need to estimate your healthcare costs. Remember that you must spend the FSA money by the end of the year (+/- a grace period) in most plans, so don’t be overzealous in maxing out your FSA if you’re not confident you’ll spend the money.

When choosing the amount to contribute to your FSA, you have to strike a balance between the probability that you will not be able to spend the money and the tax benefits of FSA contributions.

I would guess that many people contribute less than the optimal amount to the FSA account because of the strong aversion to losing the FSA money if they cannot spend it. Risk aversion is very powerful, and the pain of losing money usually outweighs the satisfaction of receiving additional tax benefits.

Conclusion

Choosing between a healthcare FSA and an HSA is a highly personal decision. It depends on your health insurance options, planned healthcare expenses, and personal preferences. I’ve laid out some considerations as you make your own decisions, but remember that there is no “right” decision. In many cases, we will choose the financially sub-optimal option because we prefer the security of more insurance.

As with everything related to employee benefits, read your health plan documents carefully and talk to your HR department for clarification before you make your final enrollment decisions.

What do you think? Are you planning to use an HSA or healthcare FSA next year? What were your considerations for selecting either (or none) of these plans?