If it’s not a clear-cut decision for you as to whether a traditional health insurance plan or a high deductible health care plan is the better choice this open enrollment season, it may be time to get deeper into the weeds by considering the tax savings of the HSA vs HCFSA vehicles.

First it’s important to realize that the tax rates effecting both the HSA and HCFSA are the same. So if you’re in the 22% federal bracket, a 7% state bracket, and then your maximum dollars are still subject to Social Security (6.2%) withholding in addition to the Medicare (1.45%) withholding, then any dollars dealing with medical issues pre-tax are at a 36.65% tax savings.

Which dollars are pre-tax?

• Both of the annual premiums (traditional or HDHP) are pre-tax. The premiums of the traditional plan will be much higher, so a guaranteed tax savings but also a guaranteed expense.
• HSA contributions, if you have a HDHP. For a family, that’s up to $7100 for 2020.
• HCFSA contributions, if you have a traditional plan. With two employees, each with a maximum safe-rollover ($300/year/employee at some employers, although the IRS allows up to $500) , that could be $600 in HCFSA dollars that aren’t subject to use-it-or-lose-it provisions, although contribution limits are much higher.

So what is the tax savings of each option?

If our traditional plan has premiums of $2000/year, at a 36.65% tax rate then if that had been taxable income it was like $2000*1.3665=$2773. And the $600 HCFSA*1.3665=$820 in taxable income. We therefore saved (2773+280)-(2000+600)=$453 in taxes by using pre-tax dollars to fund this choice.

If our HDHP has premiums of $500/year, that taxable income would have been $683. And the $7100 HSA contribution would have been like $9702. So using pre-tax dollars to fund this choice saved us $2785 in taxes!

That HDHP + HSA tax savings sure sounds like a lot vs the tax savings from the traditional plan + HCFSA, a whopping $2332 in tax savings in a single year. But it’s not quite that simple. How do you decide which is better?

• If we spend less than that difference in medical care out-of-pocket costs (via different deductibles, coinsurances, co-pays), then the high deductible health care plan with HSA is a pure win.
• If we spend a bit more than the difference, then then high deductible health care plan + HSA may still be better, because:
  • The HSA will get tax-free growth and tax-free withdrawal. We can even invest the HSA dollars, if your cash flow is such that you don’t need those dollars for this year’s medical expenses, and your HSA plan provider allows investments at low costs.
  • And we don’t have to guess about HCFSA contribution amounts (use it or lose it dollars).
• If we spend a lot more than the difference, like having a medical emergency out of network, then the high deductible plan + HSA wasn’t the best choice that year. And in fact depending on the probability of this event and the difference in out of pocket maximum costs, it may never make sense in your situation to go with a HDHP+HSA.

Additional caveats – if you have any credits, you may not otherwise be saving on your HCFSA or HSA contributions at that marginal rate. For example, if you have children, at the federal level you may be getting the American Opportunity Tax Credit and/or the Child Tax Credit (which might also come with a related Child and Dependent Care Tax Credit), lowering your effective marginal tax rate. Similarly, if your top income dollars are above the Social Security taxable maximum, that lowers your effective marginal tax rate as well, and there changes the savings effects.

The most important factor: For many people, you won’t want to get into any of this level of depth. There’s a large variability in health care expenses year-to-year for most. Instead focus on the bigger distinguishing factors , and don’t be lured into letting the tax-tail wag the health care choice dog. But if you love your spreadsheets, go for it.