HSA vs FSA For Employers

People are humans. Humans have biological needs. Biological needs require healthcare. Healthcare requires lots of money. Therefore, people need money allocated to healthcare on their behalf.

Medical Insurance covers the lion's share of our needs in the modern world, but employers know that paying for that coverage is anything but free. And even after insurance has stepped in to do their part, policy holders are often left with a copay. Wouldn't it be nice if there was a tax-advantaged way of covering those copays that benefitted employers and their employees? Thankfully there is. To paraphrase "Alexander Hamilton" in the eponymous Broadway musical when discussing marriage to a Schuyler sister, the question isn't if (there was a tax-advantaged way) Burr, but which one?

Direct Comparison

To start, let's define terms. An HSA is a Health Savings Account. An FSA is a Flexible Spending Account. As an employer, you can have both, one, or none of these: it is totally up to you. FSAs are owned by the companies, HSAs are owned by the employees individually. Both have tax advantages, but the FSA is use it or lose it. The one catch is that to provide an HSA, you must be providing a High Deductible Health Plan (low-budget health insurance). Prima facie, this sounds bad, but I firmly believe the benefits of an HSA make up for the drawbacks for most people.

FSA

An FSA is owned by the company for the benefit of the employee. Imagine it like a credit card the employer provides to the employee to provide for healthcare copays and expenses. It can be used towards prescriptions, doctor visits, and even certain health and hygiene items. An employee can siphon money out of their paycheck pre-tax, up to $2,750 each year, and the employer may contribute up to $500 also. The danger to the employee is that an FSA is "use it or lose it:" funds do not rollover year to year. They are gobbled up by the employer who owns the account.

In practice, many employees have come to view FSAs as being kind of cheap and not all that helpful. It is better than nothing, but certainly shy of a comprehensive benefits package. It is nice to theoretically have a tax-free way of paying medical bills, but there is no guarantee it will even get any use. Healthy employees rarely take advantage of FSAs because they don't expect to have medical bills. You are unlikely to succeed in using an FSA to attract or retain quality talent, so you better look elsewhere.

HSA

The Health Savings Account, owned by the employee, has far more versatility for both employers and employees. To qualify an individual to have one, the IRS requires them to have a High-Deductible-Health-Plan (HDHP). This gets a bad rap as being "cheap health insurance." Often, employees believe it is in their best interest to seek out "Cadillac" insurance benefits with fully loaded healthcare plans paid in full by their employers. These plans have super low deductibles, so the hidden costs of these plans are never seen by the employee and are not salient and tangible to them. Such plans can easily cost $10,000 per year for a single employee. Wouldn't that employee like a $10,000 raise instead if they knew?

Alternatively, HDHPs with higher deductibles that employees may be on the hook for cost somewhere in the neighborhood of $3,000-$4,000 per year for business-owners to provide. If you look at it from a raw savings perspective, you can check the box that says, "yes, I provide insurance to my employees" and move on for a lower cost. But if you want to maximize benefits for your employees, you can make contributions to their HSAs for them, and claim a tax deduction for doing so.

HSA Advanced Strategies - Better than Roth?

The annual limit allowed to be contributed to an HSA in 2024 is $4,150 for an individual, with a combined total of $8,300 per family. Those aged 55 and up can put another $1,000 in or have it deposited by their employer on their behalf. Any contribution made to an HSA is pre-tax (earns a deduction) and money used to pay for qualified health expenses (yes, even hygiene goods at Target) is tax free also. Employers get the tax deduction for contributing to employee accounts, and it helps cut back on payroll taxes too. If you don't think you will ever have a mountain of medical bills some day, let me be the first to tell you that retirement communities and nursing homes typically cost $15,000-$20,000 per month...

So if you are generally healthy, it is probably better to stockpile tax free cash in an HSA rather than overpaying for fancy insurance coverage that you don't actually need. But tragically, studies show that 95% of HSA owners treat it as just that: tax-free cash. Only 5% of people with an HSA know that you are not limited to holding cash in an HSA, even most employers have no idea about this.

You can invest in stocks, ETFs, and mutual funds within an HSA, retaining all of your tax benefits. This is an absolute game changer. A Roth IRA only gives you a tax break on your gains and withdrawals, an HSA gives you that (provided it is for medical purposes) plus a tax break on your contributions. This is the only triple-tax-advantaged account most of us have access to, we need to take advantage of that fact.

If you regularly deplete it every year as though it were cash, it may be tricky for you to reap the full reward. What I have seen the most successful clients do is to never touch their HSA money, pay medical expenses out of pocket, and save their receipts. Then, years down the line in retirement, they can take a huge payout from their HSAs to reimburse themselves for the years of expenses, provided they kept track of how much they were. Simply taking photos of the receipts and storing them in Google Drive works great.

At age 65, your requirement to use the funds for medical expenses goes away, and you can withdraw money just like it was a traditional IRA, and pay the income tax without penalty. So worst case scenario, an HSA acts like another IRA you can contribute to. Best case scenario, an HSA is even better than a Roth IRA when used to pay for health care in your latter years.

Conclusion

To wrap things up, I'm obviously a fan of HSAs much more than I am of FSAs. Providing an FSA is an ok perk, but most employees don't really care or actually use it in reality. Providing an HSA and using a HDHP with higher deductibles is actually a really great strategy for most employees. If they are relatively healthy, and you take the time to learn how to best utilize them and teach your workers, they will love you for it. We have to change the narratives we have been told, that "higher deductibles are bad," and that "HSAs are like checking accounts to pay your medical bills." Neither are true necessarily. Instead, think of it as keeping more money in your and your employees' pockets (invested in the stock market for long term tax-free growth) and putting less money into Insurance Companies' pockets.