What You Need to Know About the FEHB Program and Health Savings Accounts (HSA)
Both Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs) provide significant tax advantages, beyond those available through Premium Conversion and FSAs. The simpler case involves HRAs, where your savings account can grow if you stay with the same plan (if you change plans the entire amount is lost), and you can also use an FSA to supplement the HRA amount set aside by the plan. For example, if you expect out of pocket drug and dental expenses of five hundred dollars next year, you could place that amount in an FSA in the expectation that the HRA amount paid through your premiums would remain available for unforeseen expenses next year or in future years. Unfortunately, retirees cannot use the FSA method of supplementing HRAs.
HSAs convey far larger advantages. First, you can add to your HSA account by planning, just as if it were an FSA. Second, while you can only establish an FSA account in advance, you can add to your HSA account at any time during the year. Thus, if you have unanticipated expenses late in the year of an extra thousand dollars, in most High Deductible plans you can have a thousand dollars transferred from your pay to your HSA, lower your taxable income by a thousand dollars, pay the bill through the HSA, and obtain what amounts to a one-third discount on your unplanned expenses. Or you can transfer the extra thousand dollars even if you don't have any unexpected expenses, saving one third in taxes, and build up your account for future years. Since you retain the HSA account for life, regardless of Open Season plan changes or retirement, and it can accumulate tax-free earnings, it can become a very substantial lifelong protection against health care expense.
This account augmentation advantage is dramatic if you consider the catastrophic guarantee provided by most FEHB plans. Consider a traditional plan, national or local, that holds self-only total out-of-pocket cost to $6,000, without significant loopholes. Compare that to a High Deductible plan, with a guarantee of $7,000 for a self-only enrollment, also without significant loopholes. The traditional plan seems better. However, under the High Deductible plan your plan-paid HSA account of $1,000 (a typical amount for self only) can be used to defray large expenses, thereby reducing your potential loss to $6,000. Beyond that, you can make tax advantaged voluntary contributions of over $2,000 and pay your bills through your augmented account. This lets you save approximately $700 through lower tax payments if you face catastrophic expense. Hence, your total cost exposure is only about $5,300, lower than that claimed by the traditional plan, and reversing the conclusion as to which plan has a better guarantee. Most HDHP plans, evaluated this way, offer catastrophic expense protection as good as or better than most traditional plans.
While retirees over the age of 65 cannot establish HSAs, those nearing retirement not only can take advantage of HSAs, but also are eligible for "catch up" contributions after age 55, until enrolled in Medicare. These contributions can reduce after-tax expenses by hundreds of dollars a year more, or simply be added to the growing HSA balance. Upon retirement, the HSA balance remains available for the rest of your life and continues to earn tax-free returns. Additionally, after you turn 65, non-medical distributions from your HSA are allowed and you only have to pay your normal tax obligations on such a withdrawal.
High Deductible plans and their HSA accounts are best approached as financial planning options covering short, medium, and long terms, with savings accounts that equal or exceed IRAs in value, since the money goes into the plan tax free, grows with your investments tax free, and is withdrawn tax free if uses for health care. Since the annual contribution limits will be $3,850 in 2023 for individuals, and the typical plan deductible is about $2,000 for an individual (both amounts are roughly twice as high for families), HSA balances will likely grow even in years where health care cost are substantial, and increase rapidly in years when health care cots are low.