HSA vs PPO: Which Should You Choose?

For the longest time, I just assumed that PPO > HMO, and that anything high-deductible = bad.  At the end of each year, I would make my health insurance elections through my employer-sponsored plan, defaulting to my previously selected mid-tier PPO plan and call it a day.

Then a few years ago, the VP of HR at my previous employer introduced a new offering, the Health Savings Account or HSA. He spoke pretty passionately about HSAs, and at the end of it, I was sold. It was also the first time I felt an HR person had demystified health insurance for me, I think because he actually walked through the numbers on what you would pay in a year for various situations and different healthcare needs.

So I thought I could do the same for you in this article.

Before we start crunching numbers, a quick overview of the acronyms and plans.

Healthcare Plan Basics Overview

HMO Health Insurance Plan

With Health Maintenance Organization (HMO) plans, members typically select a primary care physician (PCP) who coordinates all their healthcare services. Members can obtain a range of services, but they must get a referral from their PCP first to see a specialist.  HMOs usually do not cover any out-of-network healthcare expenses, which means you need to stay within the HMO's network to have your services covered.

HMOs typically have smaller networks and lower monthly premiums. Healthy individuals with few medical needs might choose an HMO plan for the cost-savings.

PPO Health Insurance Plan

Preferred Provider Organization (PPO) plans offer greater flexibility and a larger network of providers.  Members can visit any in-network specialist or out-of-network provider without a referral. PPOs don't require a primary care physician and generally offer comprehensive coverage for medical needs. However, patients incur lower copay and coinsurance expenses if they use providers from the plan's network.

PPOs generally have higher premiums and lower deductibles (more on this below). If an individual requires regular specialized medical attention or has specific doctors that they want to continue seeing, that person may choose a PPO.

HDHP Health Plan

A High-Deductible Health Plan (HDHP) plan typically features lower monthly premiums in exchange for a higher deductible, meaning you pay more health care costs yourself before your insurance starts to pay. The primary appeal of an HDHP is the lower premium cost, making it an attractive option for those seeking to save on monthly health insurance expenses. However, the trade-off is that you must pay more out-of-pocket expenses before your insurance starts to cover the costs.

HDHPs have become a popular option in the last decade. In 2013, 30% of private-sector workers enrolled in HDHPs; in 2022, it was 54%¹.

HDHPs can operate under the frameworks of both HMOs and PPOs. Therefore, an HDHP can be designed within the HMO model, requiring patients to select a primary care physician and obtain referrals for specialists, or it can adopt the PPO model, offering more flexibility in choosing healthcare providers both inside and outside of the network without the need for referrals.

The criteria for an HDHP is defined by the IRS². As of 2024, a health insurance plan qualifies as an HDHP if it has a deductible of at least $1,600 for an individual plan or $3,200 if for a family plan. The out-of-pocket limit must be max $8,050 for an individual plan or $16,100 for a family plan. More on deductibles and OOP limits later.

HDHP with HSA

A Health Savings Account (HSA) is a tax-advantaged savings account only available to individuals enrolled in HDHPs. HSAs allow you to pay for qualified medical expenses with pre-tax money. Employers will sometimes partially fund this with a few hundred dollars, and patients can fund more throughout the year.

HDHPs must be used specifically for medical expenses. If you withdraw money for non-medical expenses, you’ll be taxed at your tax rate at that time. If you withdraw before you are 65 years old, an additional 20% tax penalty will be applied.

There are a few advantages to note with an HSA:

• You can contribute pre-tax dollars to your HSA. The IRS defines the limits as
  • Up to $4,150 for individuals, $8,300 for families annually
  • If you’re 55 or older, an additional $1,000 annually
• HSAs belong to you
  • Even if you get laid off, change jobs or retire, HSA funds are yours to use
  • There’s no expiration date
• They’re like 401(K)s
  • You can build up a balance and invest that money so it compound interest, and then you use that larger sum for presumably greater healthcare needs in retirement
  • Note: Different than a401(K), if you withdraw HSA funds after retirement (to use for non-medical expenses), you will be taxed at the time of withdrawal. But your tax rate may be much lower, in which case the HSA would allow you to defer and reduce taxes.
• You can open up an HSA independently
  • As long as you have an HDHP, even if the company doesn’t offer an HSA, you can open one up on your own

So how is an HSA different than FSA which is also funded pre-tax and used for medical expenses?

FSA

Most people are familiar with the Flexible Spending Account (FSA). Like an HSA, it’s another way to save for out-of-pocket medical expenses with pre-tax dollars. Unlike an HSA, FSAs are employer-owned, so if you leave the company, you can no longer access those funds. FSAs are generally a use-it-or-lose it type of thing. You must decide how much to contribute at the beginning of the year, and any unused funds typically don't roll over. You also

In 2024, the contribution limit per IRS is $3,200 for an individual or, if your partner is on your plan, $6,400 jointly

Some employers allow for carryover of unused dollars into the next year by March 15. The IRS limits this to $640.

Healthcare Insurance Terminology

Now, a crash course on the terminology you typically see in plans:

• Annual Premium: This is the amount you pay yearly for your health insurance coverage, regardless of whether you use medical services or not. It's typically deducted from your paycheck if you are employed or you pay monthly for it if you procured the health insurance for yourself.
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• Individual Deductible: It represents the amount of money you, as the insurance policyholder, are required to pay out-of-pocket for medical services before your insurance company starts to contribute towards your covered healthcare costs.
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• Family Deductible: The family deductible is the maximum amount an insured family must collectively pay before your insurance company starts to contribute to your healthcare costs. If an individual in the family meets the individual deductible first, the health plan will start covering a portion of services for that individual only.
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• Coinsurance: After you've met your deductible, coinsurance is the percentage of the cost of covered healthcare services that you're responsible for paying. If your coinsurance is 20%, and the health service costs $1000, you would pay $200 while your insurance pays the remaining $800.
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• Individual Out of Pocket (OOP) Maximum: This is the maximum amount you will pay for covered healthcare services within a plan year. After you reach this limit through deductibles, coinsurance, and copayments, the insurance plan pays 100% of the costs of covered benefits.
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• Family Out of Pocket (OOP) Maximum: This is the maximum amount your family will pay for covered healthcare services within a plan year. As with deductibles, Family OOP comes with Individual OOP.  Once an individual in the family meets the individual OOP, insurance will cover 100% of the costs of covered benefits for that individual alone.

Comparing Plans for a Family of Four

Let’s walk through a few hypothetical scenarios, comparing the potential out-of-pocket costs under each plan.

For these scenarios, we’ll assume a family of four, where one parent works for a company. That parent’s employer offers two different healthcare plans, a PPO and an HDHP, the details of each outlined below:

How do we evaluate which is better for this family’s needs? The best way to do this is to walk through a few situations with different needs and costs

Scenario 1: Minimal Medical Needs

Let’s start with the simplest scenario: the entire family is healthy, and they require no medical care outside of the regular checkups and flu shot. They would only pay the annual premium, with no need for any out-of-pocket costs

The HDHP, which has the lowest monthly premiums would yield the lowest costs.

Scenario 2: Birth of New Baby

Suppose one parent gives birth to a new baby. The cost of delivery and hospital stay is $25,000 (!) before insurance.

With the PPO Plan

• The parent would meet their individual eductible of $500.
• Their coinsurance would kick in, where the individual’s responsibility after the insurance company pays 90% is10% x ($25,000-$500) = $2,450.
• However, since the Individual OOP is $2,000 (including deductible), the individual would only pay $1,500 of coinsurance, and the rest would be fully covered by the insurance provider
• The total cost for the family comes to $14,000 when after adding back the annual premium

With the HDHP Plan

• The parent would meet their individual deductible of $3,200.
• Their coinsurance would kick in, where the individual’s responsibility would be20% x ($25,000-$3,200) = $4,360
• Since the Individual OOP is $6,500, that parent would only pay $3,300 of coinsurance, and the rest would be fully-covered by the insurance provider
• The total cost to the family for the HDHP plan comes to $11,500 after add back the annual premium

So again, when comparing solely the numbers for these specific two insurance plans, the HDHP plan wins.

The other consideration is the lumpiness of costs. With a PPO, your cost is spread out more evenly throughout the year in the form of your annual premium. The delivery and hospital stay would be a one-time, out of pocket cost of $2,000.

With an HDHP, costs can be pretty spiky — delivery and hospital stay would be $6,500 out of pocket and all at once. Not everyone has the immediate funds to be able to cover that.

Scenario 3: Healthy family who uses HSA

Now, let’s go back to the first scenario where minimal medical expenses are incurred.

Remember the HSA? Let’s say we end up choosing the HDHP plan, and we decide to contribute $583 per month, or $7,000 annually — effectively the annual premium “cost savings” from electing HDHP vs PPO.

Let’s also assume that your family is pretty healthy for the next 10 years and never has to dip into the HSA. Instead, we invest our HSA balance in a money market fund.

With compound interest at 5%, our balance after 10 years would look something like this:

Not a bad cushion for future healthcare needs.

Even if you needed to draw down that account for medical expenses this year, then the HSA would function more like an FSA, and you would still benefit from the tax savings.  It’s just that the HSA stays stay with you and doesn’t expire, which is a larger benefit over time.

Making a Thoughtful Decision

Health insurance isn't a one-size-fits-all decision. When evaluating these plans, it's important to consider your health history, anticipated medical needs, and financial situation. Every person should run the numbers for their individual or family plan options to see what works best for them.

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Citations

1 https://www.valuepenguin.com/high-deductible-health-plan-study

2 https://www.irs.gov/publications/p969#en_US_2023_publink1000204030

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