I’ve been a huge advocate for health savings accounts (HSAs) for many years. While I worked for a MegaCorp, I participated in a high deductible health plan (HDHP) and contributed the maximum HSA contribution amount each and every year that I could, viewing my HSA as a way to reduce my taxable income, pay for qualified medical expenses, and maybe even have enough left over for additional retirement withdrawals at age 65 (when money held in an HSA can be withdrawn and used for any reason). Meanwhile, I had never opened or contributed to a flexible spending account (FSA) my entire adult life. FSAs are inferior to HSAs and we had an HSA, so there was no reason to do so (plus, it wasn’t even an option with HSA/FSA coordination rules). Our situation has changed, however, and now I’m a full FSA convert as I’ve been able to successfully pair an FSA with an HSA to boost my HSA account balance.
Because of the excellent tax benefits that HSAs offer (tax-free contributions and withdrawals for qualified medical expenses), I had participated in an HDHP plan and contributed to the compatible HSA to pay for all of the qualified medical expenses in our household. After contributions stopped when I left MegaCorp, continued withdrawals took a toll on the overall balance of the HSA account.
The HSA peaked at $43,654 prior to leaving my employer in April of 2020. We then switched from that employer’s HDHP to a non-HSA connected sponsored health plan at Mrs. 20SF’s employer. With continued withdrawals for medical expenses, the HSA balance dropped to a low of $36,214 at the end of 2022.
An HSA + FSA Combo Strategy Enacted
With appealing interest rates the last few years, I was motivated to take action. I came up with a simple 2-part strategy.
- Open a new FSA to pair with the HSA, and use newly contributed FSA funds to pay for qualified medical expenses (the FSA is through Mrs. 20SF’s employer).
- Stop withdrawing funds from the HSA, and invest all of those funds to replenish and grow the HSA balance.
Why do this? You can’t invest the funds within an FSA account, while you can invest the funds within an HSA. Every dollar spent from the HSA was a dollar less invested. Using the HSA strictly for investing and the FSA for the only thing it can do (spend its balance on qualified medical expenses) would allow the HSA to rebuild over time through investment gains. The HSA has been doing just that, with funds earning 5%+ APR and paying ~$160/month in dividends per month:
Simple. But, effective.
I probably would have made this move sooner if I wanted to be more aggressive with HSA investing. Since interest rates really didn’t start climbing until the second half of 2022, there wasn’t an opportunity to do so, as you need to make annual FSA contribution elections during open enrollment at the end of the year. But, in full transparency, I didn’t even think about it. That is partly why I wanted to share this FSA + HSA combo strategy with readers, as there are undoubtedly some of you out there that could benefit from it but just hadn’t pieced the strategy together.
Who Does this HSA + FSA Pairing Strategy Work For?
This strategy would be applicable to any individual that no longer is able to make new HSA contributions (e.g. left their employer or changed to a plan that was not compatible with HSA contributions), but is able to make FSA contributions through their or their spouse’s employer.
Here are a few things to keep in mind when coordinating HSA/FSA contributions:
- Employers that allow both HSA/FSA contributions within the same year only allow contributions to limited purpose FSAs (LP-FSAs), which can only be used for dental and vision expenses, versus full healthcare FSAs. It’s better than nothing, but the majority of qualified medical expenses are typically not dental or vision for most individuals.
- For married persons, if either spouse is covered by an HDHP/HSA, the other spouse is only able to contribute to a limited purpose FSA and not a full healthcare FSA.
In our case, we were no longer covered by an HDHP/HSA, so we were able to contribute to the full healthcare FSA.
How Much Should you Contribute to an FSA?
This is the trickiest part in this strategy. You own your HSA, but FSAs are owned by your employer. And employers can reclaim any unspent funds at the end of the calendar year – which is often referred to as the FSA “use it or lose it” rule. Some employers offer either or both of 2 exceptions:
- A 2 month +15 day grace period: any unused funds contributed in a given year can be used in the first 2 months and 15 days of the following year.
- An FSA carryover rule: allowing an inflation-adjusted 20% carryover or rollover amount.
So, unlike with an HSA, where you can just contribute up to the maximum amount every year and not worry about it, it can be risky to do that with an FSA. The IRS maximum FSA contribution limit for 2024 is $3,200 per qualified FSA. I personally look at the last 3 years and go with the lowest annual spend as a baseline, and if I anticipate a big expense in the year ahead, I will adjust upward from there. Also, keep in mind that you can use your FSA, HSA, or HRA to pay for some OTC medications & menstrual care products now.
Sadly, it is not possible to transfer funds from an FSA to HSA.
A Note About HSAs
While you don’t have the ability to choose your FSA, you do have the ability to choose your HSA (here are my picks for the best HSA). Choosing one with a self-directed brokerage option can allow you to purchase whatever investments you would like, including money market funds, CDs, ETFs, mutual funds, and more. If your current employer’s HSA is not the best, you can transfer funds from it to your own separate HSA, and can even do so while you are still employed and using it. There are no restrictions against having multiple HSA accounts, so you can create a new one at any time.
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I definitely can benefit from this – having run the numbers now that I’m basically ‘out of’ tax-advantaged venues to invest money, treating the HSA as a pure investment account, and leaning on the FSA to cover all of the known/fixed expenses makes orders of magnitude more sense. I have a comparatively easy to tap into HSA if a big expense comes up beyond HDHP coinsurance if something comes up, but I can just cover the rest from what would otherwise go into a taxable investment account and feel a lot better about it this way.