“Health Savings Accounts (HSAs) are IRAs on steroids.”
– Paul Zane Pilzer, economist, author, entrepreneur, professor.
This month, we continue to explore health and wealth. Last week, we examined FSAs (or Flexible Spending Accounts/Arrangements), a tax-slashing employee benefit that most employees neglect. But there exists an even more powerful tool to wage the war against both taxes and high healthcare costs: the Health Savings Account.
If you could save hundreds, even thousands of dollars on taxes, while budgeting for health care costs, increasing health care choices, and limiting out of pocket medical expenses, would you? If so, an HSA, or Health Savings Account, may be for you. HSAs are an underutilized, yet beautifully designed financial instrument available to many Americans. What are they, and how do you tap the benefits of this alternative investment?
Approved by Congress in late 2003, HSAs are part of the new breed of Consumer Driven Health Plans – plans that, like FSAs, put more control (and responsibility) in the hands of consumers. Such health plans have risen steadily in recent years, with HSA accounts doubling between January 2008 to January 2012, going from 6.1 million to 13.5. For a speedy overview of Consumer Driven Health Plans, watch this video:
How they work: HSAs are savings or investment accounts where tax-free funds can be stored for current or future health care expenses. In 2013, contribution limits are $3,250 for individuals and $6,450 for families, with an additional $1,000 “catch up” allowed for those over 55.
“Triple Tax Free” benefits: Like a traditional IRA, contributions are tax free, reducing federal income taxes as well as other taxes. However, taxes are not simply deferred until later, when accounts (and taxes) are likely to have grown. Unused funds grow tax-free in an HSA, then, distributions are also tax-free when withdrawn for qualified expenses!
The catch? HSAs are only available to people with a High-Deductable Health Plan, or HDHP designed to be paired with an HSA. You can’t utilize an HSA with just any insurance plan. An HDHP plan will have an annual deductible of at least $1,250 for individuals or $2,500 for families.
An alternative to insurance plans that promise low deductibles but charge high premiums, an HDHP has lower monthly premiums and pays for catastrophic medical expenses (some policies also cover check-ups and some preventative care). HSAs allow consumers to use the money they used to pay in premiums and taxes to pay for their own preventative and routine health care.
Beyond HDHP requirement, there are a few other limitations:
- You cannot be claimed as a dependent on someone else’s tax return.
- You can’t be enrolled in Medicare. (Though you can still use your HSA funds for medical expenses if you are.)
- You can have no other health coverage except what is permitted. (Allowable compatible coverage includes insurance related to accident, disability, vision, dental care or long-term care, plus some other specific exceptions.)
When compared with Flexible Spending Accounts, HSAs retain the advantages of FSAs without the big disadvantages:
- Unlike an FSA, funds belong to the contributor permanently and do not expire at the end of the calendar year.
- Contributions can come from employees, employers, or a combination of both (unlike the old, cumbersome Archer MSA plans, which only allowed for employee or employer contributions in any given year).
- HSAs are not employer-dependent. They are transportable from job to job (or business to business, for the self-employed), and remain intact even if employment ends altogether.
However, as with FSAs, just because consumers are eligible for a tax-saving plan doesn’t mean they will use it. Various studies show that over a third of people who qualify for HSAs do not even open one. While confusion or procrastination may explain some of that, it’s also likely that many consumers want the low premiums, whether or not they can afford the high deductibles. High-Deductible plans are not a fit for everyone.
Who do HSAs benefit most? The big winners are twofold, and perhaps surprisingly, opposites: A), Healthy people find themselves spending needlessly on high premiums year after year “just in case,” and B), People with chronic illness or a catastrophic injury or health problem.
If you are healthy and don’t incur many medical expenses, you might save up to 70% with the lower premiums in your high-deductable plan, according to Equity Trust, a provider of self-directed HSAs. Unused HAS funds can be considered part of your savings and used for healthcare expenses down the road. Never sick a day in your life? An HSA can even be used for income disbursements like a traditional IRA (although you’ll pay income tax).
You’ll save with an HSA even if you have high medical expenses and you need to use the funds. Dan Perrin, author of America’s Health Care Crisis Solved, points out that, once you’ve met your deductible with an HDHP, the plan covers 100% of in-network health expenses. While some traditional health-insurance plans only pay 70% or 80% of expenses with no ceiling for consumers, 2013 out-of-pocket expenses are capped $6,250 for an individual or $12,500 for a family. This cap can mean the difference between a bankruptcy and a financial recovery.
Other benefits of HSAs:
They provide portable, flexible, permanent health care solutions. Too often, unemployed or self-employed also means un-insured. Rather than be tied to a specific employer or health care plan, economist Paul Zane Pilzer recommends using HSAs instead of employer-sponsored healthcare plans if leaving a job would mean losing your insurance. You can ask your employer to contribute to your HSA instead of your insurance.
Extreme flexibility and consumer choice. Qualified expenses commonly include doctor’s visits, medication, preventative care, dental and vision care. However, an HSA offers you spending and decision-making flexibility not available with most traditional health plans. You don’t have to get “approval” to see an out-of-network provider (though it might not be applied to your out-of-pocket cap), and your health insurance doesn’t even have to cover a treatment for you to use your HSA to save. Expenditures simply need to be deductible medical expenses under the IRS rules, which is quite exhaustive. (From psychoanalysis to lead-based paint removal.)
Fewer premiums down the drain. The lower premiums of an HDHP alone can save healthy consumers thousands every year.
The higher your tax bracket, the higher your savings. Adding up the savings on federal income taxes, social security, Medicare, and state taxes, higher income Americans may find themselves shaving 40% or more off of their health care spending.
This year’s contributions may reduce last year’s taxes! You have until April 15, 2013 to make a contribution to be credited to 2012. (All contributions must be made by the tax return due date, without extensions.) You take the deduction for your contribution on page one of Form 1040 under adjustments to income.
HSA Q and A:
What if you use the funds for something else? In a word: Don’t! Income tax plus a 20% penalty is collected if funds are not used for health care expenses up until age 65 (or age of disability), after which the additional penalty disappears.
What if you change your health insurance? Your HSA is not tied to a particular insurance plan, though it must be a qualifying High-Deductible plan. If the policyholder ends their HSA-eligible insurance coverage, they lose the ability to deposit further funds. However, funds already in the HSA remain available for use.
Can you double your savings by combining an HSA and an FSA (Flexible Spending Account)? If you qualify for both, then yes, but with one caveat: If you have an HSA, you can only use your FSA for vision and dental expenses.
Can an HSA be Self-Directed? Yes. According to New Direction IRA, Inc., “With a self-directed HSA account, in addition to CDs and mutual funds, you can invest in real estate, notes, tax liens, and much more-all permitted by the IRS.
However, you wouldn’t want all of your HSA funds invested in “long-term” investments, as funds should be available to use when needed. Most consumers put HSA funds in simple savings accounts or money market funds.
HSAs: The Best of Both Worlds?
If you’ve followed our P4P (Partners for Prosperity, Inc.) blog for long, you’ll know that we aren’t generally big fans of qualified plans such as 401k’s. There are disadvantages to many of these plans, such as
- The lack of control over the funds, which typically cannot be accessed for many years without paying hefty penalties and taxes, and then “must” be accessed, whether you need them or not.
- The fact that the income tax savings you enjoy on the front end can mean significantly increased taxes in later years when withdrawals are made.
While not for everyone, HSAs can be a powerful 401k alternative (or IRA alternative or supplement), providing the up-front tax savings while neatly sidestepping these disadvantages. Health Savings Accounts allow you enjoy tax savings now, while collecting immediate dividends by investing in your health now – or whenever you need to – also tax-free.
According to a Fidelity report, the estimated costs for medical care of a 65-year-old couple could be as much as $240,000, so maxing out an HSA could make a lot more sense than putting the same funds into a 401k, where you’ll have to pay income taxes on all monies withdrawn for health care (or any other purpose).
Wondering how to best invest in your Health? If you are looking for health insurance, planning for future health care costs, and wondering how to navigate the Medicare maze while maximizing your finances, we recommend our friend Dr. Katy Votava, president of GOODCARE.com. Dr. Katy helps people all over the united States plan for and manage health care costs. She offers initial consultations for only $199. To determine if the consultation will be a good fit, you can call GOODCARE toll-free at 866-696-6543 and speak with a team member.