Are the HSA and FSA bad deals?

Question

As I understand it, the HSA and FSA accounts are intended to provide individuals with a way of not paying tax on money they spent on healthcare. The individual sets up the account to receive a portion of their income every month, and this portion is not taxed. The catch is that they can only use the account for healthcare, so no buying a playstation from your FSA. That seems reasonable enough.

However, in practice:

• There is a very small cap on these accounts, usually about 3k annual. So in the best case, you only save about 1k or so.
• You can't cash out the account if it goes unspent. For the FSA, you can't get the money at all. With HSA, you pay the income tax that had originally been exempted (which seems fair) but then you also pay an additional 20% tax (which doesn't).
• It's difficult to even carry over unspent funds to the next year, eg. with the FSA.

In effect, it turns out there is a bigger catch: The scheme relies on being able to accurately predict how much you will spend on healthcare that year, and putting exactly that much into the account. If you underestimate, you will defeat the point of the account being tax-exempt. If you overestimate, you will end up losing additional money. Looking online, I see a lot of advice about "finding ways to spend your unused FSA funds at the end of the year" which seems like it's trapping you into making unnecessary spending. Besides, the whole point of insurance is to remove the element of having to bet on how much you think you will spend, and instead amortize the long tail over more consistent payments. Doesn't the HSA/FSA approach defeat this point?

There are apparently some people that also use these accounts as investment vehicles. This also seems dubious to me. With the FSA, and assuming you don't have a crystal ball, you end up having to buy a bunch of medicine you don't need it at the end of the year. Perhaps if you had a way of then re-selling this medicine at the retail price it might work, but usually prices don't work that way (and it probably counts as tax fraud). With the HSA, if you can wait until you're 65, you at least get to take the money out for free, but then it basically has the early-withdrawal risks of a 401(k), without the benefit of employer-matching.

I would imagine these accounts are a good deal if you have serious chronic conditions and spend many thousands a year on healthcare. But such a person would not benefit much from these accounts, because of how small the cap is. Not paying tax on a tiny fraction of your giant medical bill surely doesn't hurt, but it sounds like a drop in the bucket.

So who are these accounts for? What kind of person would look at an FSA or HSA account and think, "that's a great deal"?

Answer 1

So who are these accounts for? What kind of person would look at an FSA or HSA account and think, "that's a great deal"?

• FSA: Those who have recurring expenses, or planned procedures this year.
• HSA: Everybody.

The "use it or lose it" concept of an FSA means you probably shouldn't guess on how much you will be able to spend. Instead most people are better off only committing to the amount of money they know they'll spend. For someone who has recurring charges of $100 per month for covered medications and/or other eligible charges, it makes sense to commit to $100/month to their FSA to make that amount tax deductible.

HSA's are an entirely different thing. You don't have to commit any amount to an HSA. For people that live paycheck to paycheck and don't have the cashflow to contribute to their HSA, they can wait to deposit money into their HSA until they have an eligible bill to pay. So, go to the doctor, get the bill, deposit the money into the HSA, and then pay the bill with that money. In theory one could do this in real-time while standing at the doctor's office if their checking and HSA accounts are with the same bank. That way no more money is deposited than needed, but you still get the tax advantage on all money spent (up to the contribution limit). You're right that it may only save up to $1000 per year for most people, but that's still worth doing, isn't it? If you prefer, you could even pay your medical bills with your personal credit card (perhaps to get 2% cashback or points), and then reimburse yourself tomorrow, next month, or even years in the future, which leads us to:

People who have the cashflow to contribute to an HSA and potentially not spend it all that year, or purposefully not spend any of it, also benefit from it for the same reason one would also contribute to a Traditional IRA: tax deduction at contribution plus tax free earnings until you pull it out (except you have to wait until 65 instead of 59.5 to withdraw without penalty). But, it's better than a traditional IRA because between now and then, you can keep documentation and a running total of all of your eligible medical expenses for many years, and when you decide to take the money out of the HSA, (which can be anytime you want without penalty), that amount is tax free. Only the excess beyond that is taxable and shouldn't be withdrawn until age 65. It's kind of like the best of Roth and Traditional IRA combined, giving it a rare "triple tax benefit": tax deductible contributions, tax free growth, and tax free distributions for eligible medical expenses. It wouldn't be out of line for someone to max out their HSA every year, pay out of pocket for medical expenses, and have $500K after 35 years. With enough receipts saved up a good chunk of that could be withdrawn tax free. Even the healthiest person is likely to have some expensive medical expenses at some point in their life.

When comparing medical plans, make sure to take tax benefits into consideration, since even though an HSA eligible plan will have a higher deductible and MOOP (max out of pocket) than a non-HDHP plan, sometimes the tax advantages in conjunction with the lower premiums make it a better deal overall. This is especially true when an employer provides some amount of HSA contributions for you (which, by the way, does go toward your annual contribution limit of $3650/$7300 in 2022).

Side Notes:

1. There is a slight difference between putting money into your HSA yourself, and having your employer do it through payroll. Although both are fully tax deductible, when your employer reduces your paycheck, you also avoid paying your portion of FICA taxes on that amount, which saves you an additional 7.65%. (However, that reduction may also slightly reduce your max Social Security payout when you start collecting.)
2. HSA accounts are yours to keep, even if you switch employers. Nowadays many employers have a preferred bank for HSA accounts, but should also be able to direct deposit into the bank of your choice.

Answer 2

For FSA, true, only someone who is a good planner should participate. Otherwise, you run the risk of losing unused money at the end of the year. Good planners can start with health categories that are easy to predict for the upcoming year, e.g. your routine expenses for dental visits and prescriptions. Here's a planning form [PDF].

For HSA, there is no spending deadline, so some consider it an investing account. If you become ineligible for an HSA at work, or leave your job, you can roll your account over to an HSA that you personally control.

Answer 3

The HSA is the best investment vehicle (once employer contributions are maxed). This is because it is the only investment with triple tax advantage. Account contributions are pre-tax, earnings are tax-free, and qualified withdrawals are tax free. 401K/IRAs are taxed at one end or another depending on if it is Roth or regular. The HSA is the only way to avoid taxes at both ends.

Furthermore, some companies do make employee contributions to your HSA, usually as an incentive to switch to a high deductible plan. This saves money for the company, so they will often split the difference and credit it to your HSA. They can use matching or make a lump sum. This does not count as income so it saves the employer and you payroll tax as well.

Answer 4

As an additional answer that adds to @TTT's answer, putting money in an HSA during earning years and just letting it invest itself until retirement can give a very sizeable amount of money available during retirement years, when income is typically less than earning years (or relatively fixed), and medical needs are typically higher as a person ages. So it can help cover those higher retirement-age medical expenses without needing to dip into normal monthly retirement income that may not have a lot of extra available beyond normal living expenses.

Answer 5

The FSA is an OK deal, basically just a way to avoid the gigantic PITA that comes with itemizing and claiming your medical expenses when filing your taxes. If you have planned and recurring medical expenses, like an expensive prescription, regular scheduled visits with co-pays, etc, set up your FSA to cover the expected minimum and if you happen to go slightly under at the end of the year, just buy some medical durables or treat yourself to some "medical" massage for stress relief(allowable expense from a licensed therapist).

The HSA is a fantastic deal. It's a tax-free investment account(you just have to use it that way and not just keep money there like a checking account), that you can withdraw from at age 65 without paying any tax whatsoever(unlike a 401K). Functionally, you can even spend the money on non-medical expenses, because I've found that the self-checkout kiosks at most major US pharmacies are badly(or not from the pharmacies point of view lol) coded and will allow you to purchase the non-medical items they all sell using an HSA credit card. (EDIT as commenters have mentioned, this can potentially get you in trouble with the IRS, but I think that it's not the primary reason to avoid doing so --->) I have a young co-worker who gets a kick out of buying all his beer using his employer-provided HSA money(he obviously doesn't have many medical expenses, being young). But I always tell him that it's a very bad idea, since: Healthcare in 'Murica is ruinously expensive. The total for the birth of my daughter was 45K, with ~3.5K in co-pays that I paid out of my HSA. And that was for a 100% perfect, zero complications C-section. If you plan on having kids, especially more than 1, then even if you max out your contribution and invest wisely, the chances of you ever seeing any of that tax-free dough at age 65 are pretty slim. P.S. Just remembered: there is in fact a way to do so. I have a co-worker who makes a point of **never ** spending his HSA money(medical expenses are out of pocket for him), but instead uses it purely as an investment vehicle, planning to cash out tax-free at retirement. He bought quite a lot of Tesla shares on it when they were cheap and always complains about not being smart enough to buy more.

Answer 6

An FSA is a risk to the extent that you allow it to be. As others have stated, putting more in than for sure things (recurring costs that cannot really go away and being medical, will not be going down, and strongly intended planned procedures/treatments), may very well not work out.

I find it telling that in 19 years of periodically searching, I find no figures, especially from the federal government, that tell us how much and what percentage of FSA money is lost. "Telling" = powerfully suggesting it is quite a bit.

Bear in mind that people get fired, plague's run rampant ending jobs or curtailing them, doctors turn out to be moving to a different practice and you have to start over on a treatment. (Many times another doctor's work is not accepted by a new one. One cynically notes the extra fees for the repeated work, but more likely, malpractice considerations are the reason. Given either, or both, one imagines it varies across the industry as well.) Things happen.

An HSA is rather different. There just really isn't a downside except in the sense of money saved instead of improving today's life. And that is pretty personal and situational, so not too germane to a forum like this so it doesn't matter to an extent.

The tax savings are exceedingly nice and have been described already. And now that the Chinese plague has affected things, even OTC items are allowed to be paid for without a prescription. What could go wrong? And there is an asterisk to part of the tax savings. More on both in a moment.

Probably the most fantastic reason for an HSA is the required high deductible health plan. Those are treated as horrid by most who have no experience with them, quite wrongly for many considerations, but my point here has nothing to do with that perception/reality. My point is that they are health INSURANCE and what we call health insurance is utterly not. HDHP's, if they spread, will cut into the cost of medical care in a large way. Slowly at first, given the entrenched machine we have at the moment and the fact that Medicare is a huge part of that and will NEVER act like insurance, but if they were even half the market, health care costs in the US would stop rising and in practice fall due to inflation, however slowly. It took 2-3 generations to really ruin health care, and might take at least that many to fix it. What's the secret? Instead of consumers being, in practice, cut off from pricing and payment, there is no natural pressure to contain prices or to not consume an infinite amount of services. HDHP's cut deeply into both economic (not medical) problems.

So, back to what can go wrong. Well, unexpected costs usually accost families on a somewhat regular basis. The money's sitting there... but can't be used without penalty. One can try taking it and pleading an extreme situation, but I've not been able to find any figures on how much of such the IRS allows and disallows. Where does one get the money for the penalty? More non-medical withdrawal... more penalty... at least it is a closed feedback loop, but...

A minor downside is that some plan operators nitpick about every expense. In theory, they can require you show proof the expense qualifies before paying it, or you. One DOES search and find stories about that. Others, like mine, do not police it to any extent at all, as nearly as I can tell from the folks at work and my experience. I will mention that I do not mind at all whatever "arm" the government is applying to providers like drug stores making them police purchases as that goes a very long way toward reassuring me a purchase will not cause me trouble if the IRS ever audits me.

One of the greatest advantages of an HSA is the IRS is fine with you changing contribution amounts at any time. Weekly paychecks? Weekly changes if you like. You can tailor your contributions to fit life's circumstances. And it offers a rather interesting "cheat." However, one should note that there IS an annual limit and ALL money paid into the HSA counts toward it, not just that with the best tax advantage.

The limit could be an issue if working spouses contribute (almost certainly to separate plans) in the same way general tax withholding can be an issue in the same scenario. Both's contributions count into a common limit and overcontribution needs fixed and fixed soon. Not everyone is on top of things enough to deal with that kind of concern, so any problem cropping up can quickly become a big problem (even though it should be a minor issue, and even more, should never happen).

Money you never touch, that is withdrawn from your pay gets not just federal tax protection, but Social Security protection as well. Money taken from savings only gets the federal tax protection. So if you can hold off until the full amount you can contribute, or need to contribute, runs through your paycheck, you get a massive benefit. Examples given above, though not explicit about it, imply you put money into savings and have flexibility about what you use it for, only contributing it if needed. Strong implication. But that loses the Social Security tax protection.

A better way, assuming you have the money in savings of some liquid kind, and can work with a week or so's delay (or less, that'd just be the max, usually), is to see the bill and immediately change your payroll contribution. You're young and have a child born. Say that's $4,000 out-of-pocket, HDHP handling things above that. Well, you don't just pay immediately even if you have the savings. When you are ready to pay, immediately-ish or slowly over time, you bump up your contribution to whatever you are paying. Lots of variables here, so let's say you take home $478.22 a week. That includes a $10 contribution already. You tell the boss to withhold $1,000, or as much as he can. It could be done to the penny, but say that turns out to be $610 and you still take home $2.23. Once it posts in the bank handling your HSA, you pay that. That's the couple days to a week thing. One night for mine. In a slightly different variation, you pay the $610 from savings, then reimburse yourself once the money is available at the HSA bank. Rather than contribute directly from savings. Rinse and repeat.

That ability to "pivot" is a huge advantage from the HSA program. A fellow here's parents gifted him $2,000 and he did that to run the cash into the HSA. Maxed his contribution so his take home was minimal and "took" the amount contributed from the $2,000 in his checking account (from his parents). He DID have to have a bit of discipline to not overspend from a feeling of Bezos-like wealth, but as an adult, he managed that. So he got the full tax benefit as a contribution. As a gift, doing otherwise wouldn't have had any tax benefit at all. And all in keeping with the federal government's goals, his parents' goals, and his own.

A nice "cheat" available solely in the HSA program.

From helping to begin fixing America's medical cost explosion to being very flexible in practice and a huge tax saver, an HSA has no equal. There ARE practical difficulties that life tosses in, but it does the same with the FSA program, so comparing the two is a net zero there.

My strongly considered opinion is both ARE winners, not bad deals. There IS a difference in that the FSA program is a LOT less tolerant of life's vagaries, but it is still a good deal if available and used carefully. The HSA program requires less of such care and still delivers a terrific deal. Naturally, one must mind the rules and think, but then life itself is like that. Anyone with a chance to have an HSA (and the HDHP that it comes from) should jump at the chance.

Answer 7

FSA is just a gambling vessle; ignore it.

HSA is mainly useful in that lots of high-deductible insurance plans involve an employer paying into the HSA with money you would otherwise not get at all. That's far more beneficial than any possible tax breaks. If you have an opportunity to get one of these, and your expected medical expenses are low, do it! Because it basically negates the high deductible; by the time you need care, there's more than enough to pay for the "out of pocket" part with money in the HSA.

If you can afford it, and if your marginal tax rate is enough that it matters, putting some money in your HSA yourself can be a good move too. You won't lose it, you'll eventually need it (unless you die early first; otherwise everyone eventually has high health care expenses), and it saves you something on taxes.