The Power of the Health Savings Account
Traditionally, medical insurance is purchased via our employers and premiums are deducted from our paychecks in exchange for medical coverage. Health Savings Accounts (FSAs) are challenging this traditional paradigm by allowing the employee to channel the vast majority of these premiums into an FSA bank account. In exchange for holding onto these premiums, the employee must shoulder more of the deductible burden. How nice would it be to keep the premiums you would’ve been paying anyway while still having access to the identical medical plan?
High Deductible Health Plans
Individuals, families, and corporations alike share a commonality with regard to reducing overall health care costs. Collectively, we’re constantly searching to reduce expenditures pertaining to medical expenses to decrease overall cost structures. More companies than ever are now offering High Deductible Health Plans (HDHPs) with a companion HSA option. More than two-thirds of companies with 1,000+ employees are offering this HDHP/HSA option. The popularity of the HDHP/HSA combination has increased substantially over the past decade.
As of 2014, 17.4 million people were enrolled in HDHP/HSA compared to a mere 3.2 million in 2006. In brief, an HDHP is a pre-tax medical plan that requires the employee to shoulder the cost of medical expenses out-of-pocket. It must also be paid upfront to a defined dollar amount to satisfy a deductible. Once this deductible is reached, the traditional medical plan provides coverage. These plans may be a win-win for both the employer and employee over the long-term.
For 2016, a qualified HDHP translates into a medical plan that has a minimum deductible of $1,300 for an individual and $2,600 for a family. This must be met prior to insurance benefits kicking in and providing coverage. HSAs offer many great advantages to address current medical needs. They also simultaneously provide the potential for long-term account accumulation.
Advantages of HSAs
Leveraging the advantages the HSAs offered via pre-tax contributions, tax-free earnings from interest and investments, and tax-free withdrawals for qualified medical expenses is just the beginning. There’s long-term potential in the fact that unused contributions roll over each year and are not subject to the “use it or lose it” rule.
At age 65, withdrawals can be made penalty-free for non-medical reasons. In turn, it can have a very significant impact on retirement. At age 65, the HSA acts in a similar fashion as a traditional IRA. It’s taxed at the individual’s effective tax rate. Thus over the long-term, HSAs can serve as an invaluable source of retirement income while simultaneously serving as a personalized long-term health care cost containment plan.
Key HSA Points
1) All HSA contributions belong to you and are deposited into a bank account in your name
2) All HSA contributions and earnings from interest and investments are tax-free
3) Withdrawals for qualified medical expenses are tax-free
4) Unused contributions roll over each year and are not subject to the “use it or lose it” rule
5) At age 65 withdrawals can be made penalty-free for non-medical reasons
6) At age 65 one can make withdrawals for non-medical expenses and taxed at his effective tax rate on those distributions
HDHPs and the HSA Component
HDHPs include an HSA that allows employees to save tax-free money for current or future medical needs, even in retirement. Unlike a Flexible Spending Account (FSA), money contributed to an HSA rolls over year after year and is not subject to the “use it or lose it” rule that governs FSAs. The funds deposited by you and your employer into the HSA belong to you forever and are never relinquished under any circumstance, except on the account holders’ accord.
These HSA funds are not limited to the cash deposits from each paycheck. Thus, funds in excess of a balance threshold amount (typically $2,000 but usually determined by your employer and the HSA provider) are eligible for investing in a variety of mutual funds and other investment products. For 2017, the contribution limits are set at $3,350 and $6,750 for individuals and families, respectively.
If over the age of 55, one may contribute an additional $1,000 as a catch-up contribution. These gross amounts are the total amounts deposited into the HSA account between yourself and the employer. Thus leveraging the HSA, one has the potential to benefit from long-term account accumulation, interest, and appreciation while saving for future medical needs and retirement.
HDHP and Traditional Medical Plan Premiums
HDHP premiums will cost a fraction of the price when compared to a traditional PPO90 plan. This means more money in your pocket each paycheck. However, the trade-off is the financial obligation to shoulder the entire deductible upfront prior to your selected medical plan kicking in. This means potentially paying higher maximum out-of-pocket expenses.
For 2017, the maximum out-of-pocket expenses for an individual and family are $6,550 and $13,100, respectively. Note that this may change. However, many companies will have much lower maximum out-of-pocket expenses built into their HDHP.
Many companies provide corporate wellness programs that incentivize employees to maintain a preventative and healthy lifestyle. These wellness programs typically require an annual biometric screening along with a blood panel. In return, the employer will apply discounts to the medical premiums employees pay.
Factoring in the wellness discount, individual policyholders may pay as low as $0 in premiums. A family will likely pay a nominal premium for access to the HDHP. The maximum contributions to an HSA are $3,350 and $6,750 for individuals and families, respectively. For a family, medical premiums can easily run north of $6,750 annually for a PPO90 plan. Instead of paying the ~$6,750 in premiums, you have an opportunity to contribute this amount to an HSA.
The potential for long-term account accumulation using the money that normally would have been allocated towards traditional medical premiums. Channeling these funds into an HSA instead presents a financially compelling case.
Deductible and Medical Coverage
Satisfying the predetermined deductible is a prerequisite within HDHPs prior to the medical plan kicking in and providing coverage. Per the IRS guidelines, the minimum deductible is $1,300 and $2,600 for an individual and family, respectively. To encourage employees to enroll in the HDHPs, typically the employer will make a one-time annual contribution on behalf of the employee to the HSA, thus offsetting the deductible amount.
Two-thirds of employers offering the HDHP/HSA options place money into those accounts. In many cases, the employer contribution can be significant. Contributions of $500 for individuals and $1,000 for families is commonplace throughout large corporations. This decreases your deductible by as much as ~40%, rendering your effective deductible to a much more manageable amount.
In terms of medical coverage using the HDHP, the insurance plan usually covers preventative care at 100%. Additionally, all ancillary medical expenses are billed directly to the insurance company. The policyholder is charged the negotiated rates between the provider and insurance company. The insurance coverage, albeit in the deductible phase, still provides financial benefits in your favor via these negotiated rates.
All covered medical expenses are applicable to this deductible, including prescriptions. Once the deductible is satisfied, your selected insurance coverage takes over as a normal plan would. The deductible amount that one must satisfy varies from company to company, however, the minimum is set by the IRS.
The Triple-Tax Advantage and Retirement Implications
HSAs provide a triple tax advantage
1) Contributions are tax-free or pre-tax
2) All earnings from interest and investments are tax-free
3) Withdrawals for qualified medical expenses are tax-free.
At age 65, withdrawals can be made on these accumulated funds, penalty-free for non-medical reasons. This is similar to a traditional IRA at the individual’s effective tax rate.
The HSA Flexibility
HSAs have tremendous flexibility with regard to making contributions and paying medical bills on your own terms and circumstances. When electing to enroll in an HDHP, you have the ability to modify your contributions at any time and in fact, you’re not required to contribute any money at all to the HSA account.
If you’re single, in good health, and don’t anticipate utilizing any non-preventative medical treatments, you can take the employer contribution. You may pay next to nothing for the HDHP while saving thousands. In the event a medical situation arises, you can increase your contributions accordingly. Therefore, you can contribute when and how much you want at any time as your medical situation dictates. You can even make a lump sum contribution from an external bank account and make the tax adjustments during filing.
You also have the ability to pay medical bills several different ways. Using your HSA debit card at the point of sale, reimbursing yourself after paying out-of-pocket, or coordinating with the HSA provider to pay the insurance company on your behalf using the funds in your HSA account are all options.
Utilizing the HSA as a Loss of Medical Coverage Hedge
HSAs can provide peace of mind in the face of an unexpected job loss or job transition and subsequent loss of medical benefits. The accumulated funds in this account are readily accessible and will likely mitigate the loss of medical insurance since money in this account has been earmarked for medical expenses.
Depending on the account balance, this may provide the option to purchase a lower value plan and thus pay much lower premiums in a job loss situation when expenses are particularly important.
Utilizing funds normally reserved for paying medical premiums can be earmarked for an HSA to augment your long-term retirement goals and contain long-term health care costs. A family that normally opts for the PPO90 medical plan and satisfies their deductible each year can make a meaningful impact on their retirement.
These funds can be withdrawn at age 65 without penalty for non-medical reasons at the individual’s effective tax rate. This could potentially serve a dual purpose; 1) additional retirement income and 2) the flexibility to content with current and future medical costs.
For further details and plan requirements, refer to http://www.irs.gov/publications/p969/ar02.html.