October 14, 2013

Open season for health care begins for most federal workers in November each year.

Among the options for paying eligible health care expenses, you can plan to pay by using either a Flexible Spending Account (FSA) or by using a Health Savings Account (HSA). Both use pre-tax dollars to pay for medical expenses and thus save your family money, but they differ in several significant ways.

The FSA was created by the Revenue Act of 1978, and allows employees to set aside pre-tax funds for eligible health care expenses that are not reimbursed by your FEHB medical, dental, or vision care plan. The use of pre-tax money means that you can save 20% to 30% or more, depending on your family’s federal, state, and FICA (Federal Insurance Contributions Act, otherwise known as Social Security and Medicare) taxes.

Technically, there are several versions of “Flexible Spending Accounts.” Those related to health insurance expenses including dental and vision are called “Health Care Flexible Spending Accounts.” Then there is the “Limited Expense Health Care Flexible Spending Account,” which is limited to dental and vision care only, and the “Dependent Care Flexible Spending Account” for dependent day care and other associated costs. (Click here for a comprehensive calculator for both the health care spending account and dependent care flexible spending account.)

The minimum amount needed to enroll in an FSA is $250, and the maximum is $5,000.

But there is one big drawback – you have to spend the entire pre-tax savings amount in your FSA within the same tax year, or by March 15th of the following year for the previous year’s expenses. If you do not use the money for eligible medical expenses by then, you forfeit the funds. Additionally, you have to sign up for the FSAs each year to participate. FSAs thus require a significant amount of planning each year.

But with a Health Savings Account (HSA), which was created in 2003 as part of the Medicare Prescription Drug Act, you get to keep the money that you don’t use in one year and roll it over to the next, and keep adding to it. You can also invest part of the funds in the HSA to build greater wealth over the years.

To open an HSA, you also must enroll in a High Deductible Health Plan (HDHP)*. It is essentially the same type of health plan as all the others offered in the Federal Employees Health Benefits (FEHB) program, it just requires a higher deductible of anywhere between $1,250 to $12,500 (most plans are much less than $12,500 though!), depending on whether you have single or family coverage and on the biweekly premiums of each plan. In general, the higher the deductible, the lower the premiums.

In addition to the lower premiums for health coverage, many insurance companies pay a monthly cash stipend to the associated Health Savings Account to pay for eligible medical expenses via the HSA. Aetna and GEHA, for example, both pay $62.50 a month to HSAs for individual coverage and $125 a month to HSAs for family coverage.

On top of the amount contributed by the insurance companies, individuals can contribute additional amounts up to IRS limits. For 2013, those limits are $3,250 for individual coverage and $6,450 for family coverage (like IRAs and the TSP, these amounts increase from time to time as inflation increases over the years). So if your insurance company has contributed $1,500 for the year to your HSA for family coverage, you can contribute an additional $4,950. Moreover, between the ages of 55 and 65 you can contribute an additional $1,000 as a catch-up contribution.

HDHP/HSA holders can use these funds for eligible expenses like the FSA above. Or, they can pay out-of-pocket for expenses and leave the funds in the Health Savings Account for future use or to devote to investments. Any amount left over at the end of the year can be kept for future growth, as noted above.

Why the lower premiums and extra contributions on the part of the insurance companies? By taking more responsibility for basic health needs and expenses, individuals with HDHPs and HSAs use fewer resources on the part of the insurance companies, and therefore they are cheaper to insure. The insurance companies thus pass this savings on to those with HDHPs and HSAs.

Perhaps more importantly, those insured by HDHPs have “skin in the game” – since they are using more of their own money, they shop around for better services and better prices. They ask questions. They are directly involved in their own healthcare decisions. All of this contributes to driving down healthcare prices. It takes planning and preparation for expected and unexpected expenses, but in my opinion the effort is well worth the additional cushion HDHP/HSA owners can build after several years of participation in such plans. (It is also a significant part of Strategy V in TSP Investing Strategies.)

And HDHPs/HSAs are gradually catching on. I contacted Government Employees Health Association (GEHA) for growth figures of HDHP/HSA plans since they were created in the early 2000s, and here is the total number of people insured by GEHA’s HDHP:

HDHP Options

Figures courtesy of Cindy Butler, GEHA Manager of Research & Development

So if you haven’t done so already, definitely check out Health Savings Accounts associated with High Deductible Health Plans. It could be worth your while in the long run!

*Those enrolled in Medicare or Tricare are not eligible to enroll in an HDHP/HSA.

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