Smart Money Podcast: Open Enrollment and HSA vs. FSA

Liz: Welcome to the NerdWallet Smart Money Podcast, where we answer your personal finance questions and help you feel a little smarter about what you do with your money. I'm Liz Weston.

Sean: And I'm Sean Pyles. You know you have questions about how to manage your money. Well, we are here to help you answer them. Call or text us on the Nerd hotline at 901-730-6373. That's 901-730-NERD. Or email us at [email protected].

Liz: And please hit that subscribe button to get new episodes delivered to your devices every Monday. If you like what you hear, please leave us a review and tell your friends. OK, we've got one more plug before we get into the episode. We want to know, what has the pandemic taught you about money? How has the way you've handled your money changed in 2020? We're working on a special episode about all the money lessons we learned this year, but to make it happen, we need to hear from you.

Sean: We've already received some really thoughtful and interesting responses, so please keep them coming. And since I'm an audio-focused kind of guy, I'd love to actually hear as many of your 2020 money lessons as possible. That means leaving a voicemail on the Nerd hotline or emailing us a voice memo.

Liz: This episode, we're doing a deep dive into HSAs and FSAs with the help of our tax Nerd, Tina Orem. But first, in our This Week in Your Money Segment, Sean and I discuss open enrollment, which is currently happening for a lot of people.

Sean: That's right, we've entered that magical and maybe headache-inducing time of year where we make decisions about what kind of health insurance we want in the next year. And there's a lot to consider when you're making this decision.

Liz: And actually, it's more than health insurance. It's all kinds of benefits if you happen to be employed by a company who offers benefits. But also there's the Medicare deadline and the ACA deadlines. So they all kind of come together right now.

Sean: And that's one thing I wanted to lay out right off the bat, is all these different deadlines here. So for marketplace plans like healthcare.gov and state exchanges and individual plans, you have from Nov. 1 until Dec. 15 to make your decisions. If you have employer-sponsored healthcare, like Liz and I do, these will vary. We had a couple of weeks to make our decisions and we actually just finished our enrollment period. And then for Medicare, you have from Oct. 15 to Dec. 7. And for Medicaid, there actually is no restriction and you can apply at any time.

Liz: And the Medicare one is when you typically are switching plans, if you want to do that. You sign up initially within seven months of your 65th birthday, so either the three months before or the three months after. Make sure you understand all those deadlines because there can be lifetime consequences if you miss your enrollment period.

Sean: Or, if you don't enroll for your health coverage, even with your employer, then you just won't have health insurance next year, which, in the middle of the pandemic is not a great idea.

Liz: Yes, definitely sign up, please. If you've got access to it, let's do it.

Sean: So I want to talk about the process for choosing your healthcare plan and different things that people should consider. What do you think people should be aware of?

Liz: Well, obviously, the first thing is do it.

Sean: Yes, yes, yes.

Liz: But don't necessarily just pick the health insurance you had last year, because things are changing all the time. And that's true with everything, Medicare, with ACA, with everything. Deductibles might change, the networks might change, the drugs that are covered might change. So unfortunately there's no shortcut to this. You actually have to look at the information and make a decision based on your circumstances.

Sean: Right. This is the one time of year where it makes sense to sit down, spend a little bit of time digging through these numbers and thinking about what kind of coverage you might need for all of your various factors, and getting the thing that's right for you. Because once you make your decision, this is going to affect the health coverage that you have all of next year.

Liz: And also, it's a good time to take a look at what your other benefits might be. Again, if you have employer-provided benefits, you might have a lot more than you know. Some companies are offering pet insurance and a lot of companies offer prepaid legal. And let me say, that prepaid legal can come in really handy. It can help you write that will that you've been putting off and getting those healthcare documents that you need.

Sean: Yeah.

Liz: And it's either low-cost or free, which is great. There also could be mental health support. There could be all kinds of little niceties that your company is paying money for, so you might as well take advantage of them.

Sean: And telemedicine is a new one of those that I think a lot of companies have adopted, especially in the past year. And if that's something that you can make part of your benefits package, then I think people should really dive into that and make sure they have that available for themselves.

Liz: I was really pleased with our company's version of that, because I was able to make, if not a same-day, a next-day appointment with a doctor. It didn't feel like there was a rush. I was able to talk to her about a bunch of different things and get some clarity on some things. And that was really nice. I really liked that.

Sean: Well, I've heard from some friends who've done this as well, and they expressed something similar, that they felt like they actually had more one-on-one attention having a telemedicine appointment versus having an appointment in an office where doctors are often rushed from one appointment to the next, which is kind of ironic. You think that you wouldn't have as good of attention over the internet, but because you're in that one-on-one Zoom session with your doctor, it's a little bit more intimate.

Liz: Exactly.

Sean: One thing that I also wanted to talk about was people who've lost their health insurance this year, because they've maybe been laid off from the pandemic.

Liz: Yeah.

Sean: For the folks who are doing that, they're likely going to have to get directed to ACA plans through healthcare.gov. Again, I think it's really important for people who, maybe even if they don't have the best options available to them, to consider all of these different factors in terms of what coverage they might need, whether they can have their prescriptions covered, so that they are getting the robust coverage that they need for themselves in 2021.

Liz: And keep in mind that those ACA, also known as Obamacare, exchanges will offer you essentially subsidized premiums. It's tax-subsidized, so don't think that you have to pay the full freight like you do with a COBRA plan. That's the one that's usually extended after you lose your job.

Sean: And no matter what, makes sure you get that coverage, because going bare is never a great idea.

Liz: It only takes one accident or one illness, like can happen in a pandemic as well as any other time, to really saddle you with just life-altering, bankrupting bills. So it's definitely worth having.

Sean: Yeah. And unfortunately, given the very dysfunctional nature of our healthcare system, medical bills are often one of the leading reasons that people go into bankruptcy or even go into poverty. So doing what you can to make sure that you have the coverage that you need if you do get medical bills, having ones that are more affordable, can go a long way for keeping you more financially sound over the long run.

Liz: And if you have any questions about your employer-provided benefits, your human resources department is a great option for getting those questions answered.

Sean: We have this excellent article that's actually a step-by-step guide to choosing a health insurance plan. Shout out to Lacie Glover who wrote that. So if you are having a hard time figuring out all of the different factors that you need to consider and what might be the best option for you, and also wading through the alphabet soup that is all of these different healthcare options, check out that article. Liz will link to it on our show notes post. It's worth the read.

Liz: Absolutely.

Sean: All right, and with that, I think we can get onto this episode's money question, which comes from Clement in Denver. They ask, "Which is better, an HSA or an FSA?"

Liz: OK, this one's going to be complicated.

Sean: Yes. But fortunately, to help us answer Clement's question, on this episode of the podcast, I'm going to throw a bunch of questions at Liz, who knows this stuff inside and out. And we're also going to have our go-to tax nerd, Tina Orem, on to help us understand the tax implications of each option.

Liz: So pleased to have Tina on. We haven't had her on before, and I'm really excited. So hi, Tina.

Tina Orem: Hi there. Good to be here.

Sean: Welcome to the show. It's so good to have you on. To start, let's just first break down what an FSA and an HSA is, and talk about some similarities and differences. Tina, can you lay that out for us?

Tina: Sure. So generally speaking, an FSA is a workplace benefit. So it's offered by your employer. An HSA, similarly, is available really only to people who have high-deductible health plans. So not everybody qualifies. But from a tax perspective, they can both really save you some money.

Contributions to an FSA are pre-tax, directly from your paycheck, so that means you don't pay taxes on the money you earn if it goes right from your paycheck into your FSA account. HSA contributions are similar. The contributions are tax-deductible, and that can lower your tax bill. And one of the great things about that is you don't even have to itemize to claim the deduction. You may have a few extra forms to fill out, though.

Sean: One thing that I want to lay out as well, is this what these letters mean? FSA stands for a flexible spending account whereas HSA is a health savings account? Are there any key differences? What makes the FSA more flexible versus the HSA?

Liz: The weird thing is that the flexible spending account is actually less flexible than an HSA. So with the flexible spending account, you have to spend the money by a certain point or you lose it. With the HSA, you can roll the money over from year to year. And in fact, because you can do that and because you can invest the money, it's not just sitting there in cash.

A lot of financial planners like HSAs almost as much as they like 401(k)s. It's like they tell you to put money into a 401(k) to get the match, and then they say, "Put money in an HSA, because it's so flexible." And it has what Tina will tell you is a triple tax advantage. Can you talk about that, Tina?

Tina: Sure. Contributions to an HSA can be tax-deductible. So that's one advantage. Second is that the growth within the account obviously is tax-advantaged. And then third, withdrawals from the accounts — if the money is used for qualified health expenses, is not taxable.

Liz: So if you do pull the money out, use it for medical expenses at any point, including in retirement, you're golden, which is pretty cool.

Sean: There's a pretty significant catch with HSAs which make me somewhat skeptical of them, and that's that you have to have a high-deductible health plan or HDHP. And that makes me a little bit nervous I think in part, because I tend to be conservative when it comes to things like this. I don't want to have a lot of out-of-pocket healthcare expenses. How do you guys think about that factor?

Tina: One of the great things about the HSA is that the money is not a use-it-or-lose-it kind of account. So you get to keep it forever. So if you are nervous about maybe not spending all of the money that you plan to contribute for the year, don't be. You can keep it. There is no expiration date on it.

Liz: So I think Sean, what you're nervous about is the high-deductible plan itself, that as an option?

Sean: Right, yeah.

Liz: So, a high-deductible plan is not for everybody. I mean, your deductible might be thousands of dollars, and if you don't have that money sitting in cash or in the HSA and you would be tempted to skip healthcare, then I would say a high-deductible plan is not for you. And also, if you have kids, I would really do the math, because we tried this one year and it didn't work out so great for us. Kids are in the doctor's office a lot, so one of the things you probably should do is look at your healthcare spending for the previous year, and see what you would've paid if you had a high-deductible healthcare plan versus the one you actually had, and that might help you make up your mind.

Sean: I know that's technically correct and that's how I should be approaching this, but I'm more nervous about my future potential costs, because we're in the middle of a pandemic and things seem so uncertain right now that I'm still wary of that high-deductible plan. But maybe that's just me.

Liz: No, I don't think it is just you. I think people do have understandable concerns about this. But, again, if you are able to do the high-deductible route and you wouldn't skip treatments or medical care, those HSAs have great advantages. I'm glad I did it the year that we did, because I've got this little pile of money that I keep investing and it keeps growing, which is great. But, as we said, it's not one size fits all.

Sean: Well, how can someone tell if an HSA or an FSA might be better for them? We talked about a couple of the factors, but is there anything else that people should keep in mind?

Tina: With regard to FSAs versus HSAs, an interesting thing about flexible spending accounts is that they're actually two flavors. One is for health expenses. But some employers also offer dependent care FSAs, and those are generally for things you would think of as daycare expenses, child care expenses, if you need them to look for work or work. So that can be another way to stretch your budget. Not necessarily just for healthcare expenses.

Liz: So if you're not going the HSA route and you want to do an FSA, can you put a certain amount in the FSA for dependent care and then another amount for the medical side, or is it a total cap? How does that work?

Tina: Right. There are limits. So, for health FSAs, you can contribute in 2020 up to $2,750 in an account. If it's a dependent care, FSA up to $5,000 a year can be excluded from your income. This means if it goes right from your paycheck into your FSA, it is money that is not taxed. So that can stretch your budget.

Liz: Yeah. Not taxed at all? Not even payroll taxes?

Tina: Correct.

Liz: Woo. OK. Well, that's nice. But can I put $2,700 in the healthcare side and then another $5,000 in the dependent care?

Tina: It depends on your workplace plan. So you need to check with your HR department to see what's available to you.

Liz: Well, I love this, because there's not very many ways that people who get W2 income can control their tax bill. Most people choose not to itemize. They're going to take the standard deduction. So something that shaves money off the top and particularly shaves money off so that you don't have to pay payroll taxes, that's a pretty good deal.

Tina: Now, there is one key thing to remember with FSAs in that they can be, in general, use-it-or-lose-it accounts. So employers, however, can choose, if they want to choose, to allow you to carry over some of the money for a few months into the following plan year. So you need to check with your employer about what the rules are. And because of COVID, the IRS has recently given employers some additional flexibility about letting people carry money over. Obviously, if you've been putting money into a dependent care FSA for daycare and the daycare has been closed, that's of concern. So you should check with your HR department to see what your employer plans to do with the plan rules to maybe have some flexibility for you. But, again, that's different than an HSA where the money is yours to keep as long as you need it.

Liz: And one of my favorite tricks is with the healthcare FSA, it's spending it as early in the year as possible, because with the other kind, the dependent care, you can only spend the money as you put it aside. But with the medical FSA, you can spend the money Jan. 1 or Jan. 2, even if you haven't already put it in there. We've done this a couple of times when we switched jobs, we actually were able to spend more than we put in. So that's just a thought.

Sean: Interesting. So if you leave the job that funded that account, you wouldn't have to pay it back, even if you already spent the money?

Liz: Yeah. The idea is that the employer, with the use-it-or-lose-it provision, the people who aren't spending the money are offsetting the people who ... game the system, like I did. I mean, that's the only way to put it.

Sean: Right. But it's totally aboveboard. You're just being pretty clever about how you're using this.

Liz: Yeah, exactly.

Sean: Well, is there anything else around funding these accounts that people should know about?

Tina: No. I mean, I'm thinking about, from a tax perspective, if you know you'll need to spend money out of pocket on medical care or childcare this year and you have access to an FSA or an HSA, then running your money through one of these accounts before you pay the doctor or the daycare provider really can save you money. You can get 100% of the money you earned instead of 100% of the money you earn minus taxes, which is generally what would happen if your employer just deposited your paycheck in your regular checking account.

The thing to remember is that the money in your accounts need to go to qualified expenses or else it blows up the tax benefits. So if you're curious about what exactly counts, I would say, go to your employer, which probably has a list or a guide of qualified expenses for you. But look there first if you're curious about a specific expense.

Liz: There's one more tip I wanted to throw in having to do with health savings accounts. Those are the ones that go with the high-deductible plans. And that is a lot of people choose not to use that money for medical expenses. They just keep rolling it over year after year with the idea it's going to pay for medical expenses in retirement. But you might want to keep track of your medical spending anyway, and your receipts, because you can use those to take the money out tax-free at the end, even if you don't have medical expenses that match up.

Did that make sense? It's basically, as long as you collect the receipts as you have the expenses, you can use that money at any time. You don't have to match it up to the year where you actually incurred the expenses.

Sean: Oh, that's excellent. OK, you're selling me on these accounts now, even though I'm somewhat wary of them.

Liz: I think wariness is justified, but especially if you're young and healthy, I think it's worthwhile at least investigating the HSA and seeing if it might be a good fit

Tina: And on that note, I look at tax documentation all the time, and for people out there who want to read the rules, who really want to know all the details, there are two good places I would send you. The first one is IRS Publication 969, and that has rules for HSAs and FSAs. And another one is IRS Publication 502, and that's all about what counts as qualified for medical expenses.

Liz: Oh, those are great resources. Thank you, Tina.

Sean: All right. We can link to those on our show notes post, if you want to get super extra Nerdy like Tina and read these actual tax documents here. Circling back to Clement's question, which is better, an FSA or HSA? It seems like the answer is really it depends based on your healthcare needs, your financial circumstances, and your tax goals. Is that right?

Tina: I agree with that. Everybody's tax situation is different, everybody's. So there's no way to say that one is always better than the other for all people. One thing I'll add is that in addition to the tax savings, sometimes employers contribute to FSAs and HSAs, and so that's like free money. So, again, if you have access to these accounts and your employer is matching or contributing, throwing money in as an incentive, definitely try to take advantage of that if you can and if it works with your situation.

Sean: So that could make the HSA like a quadruple win financially, because you're getting the tax benefits threefold plus the free money from your employer potentially.

Tina: Yes. Yes, it's possible.

Sean: And this just requires touching base with your HR department, and if they don't have this benefit, maybe lobby them a little bit and see if they can do that next year.

Tina: That's right. Be sure to read what your HR department sends out. Look at it carefully and ask questions.

Sean: Well, Tina, thank you so much for joining us. I really appreciate it.

Tina: Anytime.

Sean: With that, let's get into our takeaway tips, and I can start us off. First up, it's not one size fits all. Everybody's tax situation is different, so spend some time researching your options.

Liz: Next, HSAs could be a quadruple win. But HSAs require a high-deductible health insurance plan, and those aren't for everyone. FSAs could be a better fit.

Sean: Lastly, you have a limited time to act. The time to choose and sign up is during open enrollment.

And that is all we have for this episode. Do you have a money question of your own? Turn to the Nerds and call us or text us your questions at 901-730-6373. That's 901-730-NERD. You can also email us at [email protected] and visit nerdwallet.com/podcast for more info on this episode. And, of course, remember to subscribe, rate and review us wherever you're getting this podcast.

Liz: And here's our brief disclaimer thoughtfully crafted by NerdWallet's legal team. Your questions are answered by knowledgeable and talented finance writers, but we are not financial or investment advisors. This Nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.