We’re back with another round of yearly open enrollments, benefit choices and premium increases and I thought it’d be a good time to talk about Health Savings Accounts(HSAs), an underutilized tool when it comes to saving for you retirement(early or otherwise).
An HSA is the most tax-advantaged account available to most investors and has many benefits that make it very attractive to most individuals. However, it is not one that’s commonly discussed in the same areas as IRAs or 401k and that’s a shame because HSAs are probably the best of breed when it comes to retirement savings accounts.
The goal of an HSA was to shift at least part of that subsidy from the employer to the employee. The employer would get less of a subsidy in the form of tax exemptions due to the lower premiums that are inherent with a consumer based plan that is needed for an HSA. The employee would now get to benefit from this change in two ways – a reduction in employee paid premiums and the ability to reduce taxable income via contributions to the HSA.
In essence, the idea with the HSA was to transfer some of the tax exemption subsidy historically given to the employer to the employee.
To qualify for an HSA, a person must be covered by a high deductible health plan(HDHP). An HDHP is a consumer based plan that puts the first dollar costs of healthcare on the plan participant(you) instead of the insurance company and in doing so reduces the premium. It places more risk on the enrolled and less risk on the insurance company.
The goal was to pair the HSA with a plan that was designed to move to the tax exemption subsidy from the employer(employers pays less in premium and get less of a tax exemption) to the employee(the employees cost-share of premium is also lower and they can now invest the additional $$ saved in premium from a traditional plan design into an HSA and get that same tax-advantage).
- A minimum deductible of $1300 for self coverage and $2600 for family coverage
- No copays; medical or prescription before the deductible is met(some preventive copays may be allowed)
- A maximum out of pocket max of $6550 for self coverage and $13100 for family coverage
- Must cover preventive visits at 100%
- Can offer 100% coverage after deductible is met but often has coinsurance and rx copays after deductible until out of pocket maximum is reached
The downsides of an HDHP are pretty clear based on the above information and that’s the fact that the potential first dollar dollar costs before insurance kicks in at all are pretty high.
If someone has family coverage, they may have to pay $2600 before insurance cost sharing of any sort kicks in and that would not be the end of it depending on the type of coverage they have. That’s not an easy pill to swallow for those who are used to the predictability of a copay structure plan design.
That brings us to one of the main concerns around switching to an HSA eligible plan design and that’s the question mark around cost.
If you have a $30 copay then you know that your doctor visit or specialist visit will cost $30 but if you have an HDHP then you get billed the insurance negotiated rate with that doctor which is difficult to predict and can be in the hundreds of dollars for specialist visits.
In general, the upfront costs are a lot higher with an HDHP since you have no copays in the beginning. Copays may come into play after you meet your deductible but that first dollar outlay($1300/$2600 or more) is 100% the responsibility of the insured so if you’re very worried about cost predictability then an HDHP may not be for you.
The benefit of an HDHP is the premium savings that can be had and they can be substantial and worth the risk especially once you take all the tax benefits of an HSA into account.
The Kaiser Family Foundation says that only 55% of plans had a deductible in 2005 but how many of you have a plan with no deductible or even know a person who does now? They still exist especially in government/union jobs but they are far less common.
Enrollment in HDHP plans has doubled from 2010 to 2015 and HDHP plans now make up nearly 1/4th of all the plans offered now as deductibles grow each year. In fact, deductibles have grown 67% in that same time period and show no sign of slowing down.
Most Americans are familiar and participate in tax-advantaged retirement plans like a 401k, 403(b), IRA or Roth IRA but many still aren’t utilizing the HSA. That’s a shame as it is probably the best account available to them when it comes to the tax-advantages it offers.
An HSA is especially attractive for those retiring early because unlike the other tax-advantaged savings accounts; the funds aren’t locked up until a certain age if used for qualified medical expenses.
For 2017, the IRS allows an HSA account holder to contribute up to $3400 into the account for an individual account and up to $6750 for a family account. If you’re over the age of 55, you can make an additional catch-up contribution of $1000.
Most employers who offer an HDHP paired with an HSA will also make an automatic contribution towards your HSA each year to help with some of the first dollar costs for those that don’t or can’t contribute. Do note that any money the company contributes towards your HSA IS counted towards the maximum unlike a 401k. That means if your employer contributes $1000 towards your HSA during a calendar year, your maximum for that year would be $2400.
That money can be used to pay any medicals bills under your plan and help meet your deductible so it offsets some of the initial risk burden that comes with an HDHP plan.
After all, people used to a $25 copay may be shocked to find that a doctor visit actually costs $140. The idea behind these plans is that you save the additional dollars saved via premium reduction into an HSA to cover but the real benefits of an HSA and any dollars you contribute towards it are the tax benefits that come with it and how they can help you save for your future.
- Contributions to an HSA are pre-tax just like a traditional IRA or 401k.
- The other big benefit is that if your HSA is offered through your employer and you make payroll deposits into your HSA, your contributions are not subject to FICA which is another 7.65% savings over a standard tax-advantaged retirement account.
- If you make the contributions with after-tax dollars and not through your paycheck then they are tax deductible at the end of the year but you miss out on the FICA benefit.
- Withdrawals from an HSA are tax-free if used for an eligible medical expense. That’s huge and means you never pay taxes on money in an HSA as long as it is used for a medical expense.
- Earnings in that account are tax-free as well just like an IRA or 401k. Most HSA accounts allow you to invest money in mutual funds as well. Some require a certain dollar amount in cash before they allow you to invest in mutual funds.
- The funds in the HSA are yours to keep forever and they can grow tax-free for as long as you want them. This is unlike an FSA(your own money – tax deductible) or HRA(employers money) which are gone after the calendar year or not yours to keep.
You can see that an HSA essentially functions like a 401k with a few added benefits. You can avoid FICA(7.65%) if the contributions are made through your payroll and pay no taxes or penalties for taking the money out early if it’s for an eligible medical expenses.
The triple tax benefit of an HSA(tax free contributions, tax free growth and tax free withdrawals for medical expenses) are huge and make an HSA a very appealing investment vehicle for early or regular retirement.
Also note that in most states HSA contributions are pre-tax for state taxes as well. This is not the case in Alabama, California and New Jersey. Certain states like CA(no tax benefit at all for state taxes!), NH and TN also tax the earnings in the account making them less desirable in those states.
There are some obvious issues here that come to mind.
One of the first ones deals with someone who doesn’t have any medical expenses and an HSA effectively becomes an IRA after you turn 65 for that lucky person. Once you turn 65, you can withdraw money for regular living expenses with no penalties as long as you pay income tax which effectively means it functions like an IRA or 401k although it doesn’t have some of the early withdrawal opportunities those accounts have. You can also take money out of the HSA for other purposes before 65 but have to pay a 20% penalty so that should only be used as a last resort.
The other question mark is what happens to HSAs if the US healthcare landscape ever changes(socialized healthcare for example). That’s hard to figure out although it’s possible they’d simply convert to standard retirement accounts in that scenario since they already function that way after 65 anyway.
Another is the an issue someone’s who not healthy might run into because an investment vehicle requires time to function well so if your goal with an HSA is to save money for retirement then you need the wonder of compounding to make that money grow for you. If you’re spending your entire account value each year to cover your deductible then you’re not growing anything and that is an issue.
Even in a scenario like that you’re still benefiting from maxing out the HSA because you’re effectively not paying any taxes on any HSA contributions and medical expense.
However, there is a key quirk of an HSA that allows you to take advantage of the tax-free growth even if you’ve got medical bills.
As of right now, you can actually use post-tax money to pay your medical bills now allowing your pre-tax dollars to grow for the future. Then you can take HSA dollars out of the account years later against those medical bills.
That means you can have a bill for $1000 in 2016, use non HSA money(post-tax) to pay for it and let your money grow tax free until 2026 when you retire. Then take out $1000 to reimburse yourself for that payment with no penalty or tax bill. The laws may change in the future so I wouldn’t count on this forever but right now that option is available to you as an HSA account holder.
Do note that keeping receipts for qualified medical expenses with an HSA is key in case you get audited.
Another benefit is that HSA funds like other retirement accounts are portable so you can take them with you whenever you switch jobs or want to change your HSA administrator.
The truth is that medical costs are expensive and not everyone can afford the type of plan design that is needed to set up an HSA.
The upfront medical costs that come with an HDHP plan can be very high and some of these plans come with deductibles that are as high as $6000 which means you’ll pay $6000 before the insurance covers anything. The reality is that some people may not have an option as that type of plan is the only affordable medical insurance and for a lot of people an HDHP is the clear option when you compare the premiums of an HDHP and a traditional copay plan.
Do note that you can have a traditional plan after you’ve started an HSA. You just won’t be able to contribute to your HSA account that year without an eligible HDHP plan.
If you know there are medical expenses coming up in a given year and your employer offers an affordable traditional plan alongside an HDHP plan then you can switch to the traditional plan for one year – get all your medical expenses out of the way and switch back to an HDHP. You’ll miss one years worth of contributions but it can be a financially advantageous decision depending on plan designs and premiums.
The reality is that HSAs aren’t for everyone. Those that have affordable high quality healthcare coverage through their employer may not want to take the additional risk that comes high deductible plan designs and that’s understandable. HSAs offer great tax benefits and potential for increasing your tax-advantaged retirement savings but that doesn’t necessarily make them an obvious choice for everyone.
If the premium cost difference between a plan that exposes you to thousands of dollars in deductible expenses and a plan design that covers everything is negligible then there’s no way I’m taking the HSA eligible HDHP plan. I still think those situations are rare aside from certain industries and most times there will be clear premium savings when comparing an HDHP plan versus a traditional copay plan and there’s where HSA eligible plans start making sense.
It really comes down to what your employer contributes towards your healthcare, what options they offer and whether the financials of choosing an HSA eligible plan over a traditional plan make sense for you. If you can save a significant amount in premium on an HSA eligible plan and put that money towards your HSA then it might make sense for you.
The simple analysis to do when comparing an HSA eligible plan against a standard plan is to take the premium savings offered by an HDHP plan and weigh it against the additional risk that type of plan puts on you and decide whether that is a risk you’re comfortable with. An HSA eligible HDHP plan will allow you to save additional money for your retirement but does offer more potential for increased upfront medical costs. As with any financial decision, the type of risk you’re comfortable with is a personal question that should weigh the potential savings increases versus the potential increased cost exposure and take into account your personal health and other variables.
The individual exchange offers a perfect example of the premium differences you can see from going to an HSA. Here are two actual plans I found on the exchange today and how they compare in cost.
The above layout is a basic benefit structure and cost for two separate medical plans for a 45 year old man. You can see that the traditional copay plan is a lot more expensive than the HSA eligible plan($3284 more expensive) but offers much better benefits. It has copays, a lower deductible and a lower out of pocket maximum.
While the HSA elgibile plan has a much higher potential out of pocket expense, it gives the person choosing the HSA over $3000 in premium that they could use to almost max out their HSA. In doing so they take on additional risk in the form of much higher first dollar costs.
What’s interesting in this scenario is that a person who meets the out of pocket max in both plans is actually better off with the HSA plan than the traditional plan as they save $3200+ in premium but only pay $3050 more in out of pocket costs. That makes it seem like the HSA is an obvious choice here but that’s only one specific scenario and insurance is all about potential scenarios. HSA eligible plans will be better in certain circumstances but copay plans will be better in others and the premium difference is often smaller than this example making it less clear.
Another thing I typically look at when comparing plans is what happens in certain scenarios and see if you’re comfortable with the risk around those scenarios..
As an example, traditional copay plan has a $100 ER copay and an ER visit is often $1000 dollars a pop. Imagine a person who has 5 ER visits during the year. With the HSA plan, they’d pay $4172 in premium then $5000 in ER costs for a total of $9172. With the traditional plan, they’d pay $7457.64 in premium and $500 in ER copays for a total of $7957 – not a huge difference but in this type of scenario the traditional plan wins.
Keep in mind that the HSA offers the ability to save $3400 in pre-tax dollars potentially saving the HSA eligible enrollee additional tax savings($850 if they’re in the 25% tax bracket) so that brings the difference closer.
There are other scenarios to plan out like rx expenses and doctor visits as the copay plan has rx copays between $5 and $50 dollars and doctor copays in the $20 range so it all depends on your expected costs in all these medical categories.
In this scenario, the HSA would be a better deal if you’re really healthy(as is almost always the case for healthy people), or sick enough to hit the full OOPM. The copay plan would likely be better in a variety of scenarios where the copays are utilized quite often but you’re not quite hitting the HSA OOPM.
I think in this comparison, I’d lean towards choosing the HSA because the premium savings is pretty large versus the risk potential I can see but the potential scenarios are always different and varied and depend heavily on plan design and premiums and your own utilization. The plan differences(premiums) between these two plan designs might not be the same in every state and with every carrier as the actuarial values between plans can vary between carriers making one a better deal than the other.
Even if an HSA seems like it might make sense, a lot of people simply love the certainty of having a copay versus high deductibles and if they’re lucky enough to have their employer pick up most of the cost of that $7400 annual premium then the decision can be pretty clear in the other direction. It’s a lot easier to budget for doctor visits when it’s a $20 copay versus a potential $200 outlay when the premium cost to you is very low.
However for those that are going through the exchange with no subsidy or employer contribution, the choice can be more murky.
I’d urge people who are unsure about that decision to do a similar high level look around benefits including copays and then compare expected costs around certain scenarios and see if you’re comfortable with the risk versus the savings. There are calculators out there that you can use to compare two plan designs based on their benefits and premiums.
There are also situations where the choice is already made for you as more and more employers are starting to offer HDHP plans with no other choice. In those scenarios, I would certainly advise putting as much money into an HSA as possible and taking advantage of the tax savings that come with it especially if you’re doing the contributions through your paychecks and saving on FICA as well.
The ability to save for your future healthcare benefits is important as those will be a big portion of your expenses as you get older. Just looking at those premiums for the individual exchange plans for a 45 year old man makes me realize that an early retiree now could be on the hook for as much as $11000 any given year if they have health issues and that’s for a single man without family coverage. Family coverage could easily mean a potential outlay of $20000+ with deductibles doubling and premiums going higher.
In my opinion, the HSA should be the second target for those saving for retirement. First, you should make sure to get your employer match in your 401k then max out the HSA before returning to the 401k. The HSA functions much like a 401k but offers all the other benefits we’ve discussed already that make it a better choice.
There are some exceptions here and I assume that your HSA does offer investment options that aren’t cost prohibitive(very high expense ratios) versus your 401k and doesn’t have outrageous fees. The 401k also offers some other benefits that an HSA does not like bankruptcy protection(HSA has that as well in certain states) and the ability to take advantage of such things as 72t early withdrawals but those don’t necessarily apply to everyone.
That means that if you’re thinking of retiring early then an HSA does have less options for tax-free withdrawal unless you’re spending the money on medical expenses or using it to cover some past medical expense. Most people who are thinking of retiring early should already be maxing out their 401k so it shouldn’t be a choice of one or the other but both if possible. I just wish the annual contribution limit for an HSA was a bit higher!
The HSA is a no brainer for those who have access to it and are already maxing out their other tax-advantaged account or make too much to be eligible for a Roth or Traditional IRA. Those who aren’t quite maxing their other accounts should still make use of their HSA if available as it offers a lot of benefits that make it better than the other available investment accounts.
I’ve been using my HSA for a few years but only recently started maxing it out every year after reading more about them. Most people don’t see the HSA for the retirement vehicle it is and that’s a mistake because it’s one of the best ones out there and should definitely be at the top of any list for savers. Healthcare expenses are almost guaranteed to be a big part of your expenses in early or late retirement and it is great to have the ability to pay for those expenses with no tax obligation after letting it grow tax-free for decades.
These days a lot of HSA administrators offer fund selections and fee structures that compete with most 401ks making them an excellent choice for your investment dollars. That means that if you’re looking to supplement your tax-advantaged savings account then an HSA is a great choice as long as you can make sense of the premiums and extra risk of an HSA eligible plan against a traditional copay plan.
How many out there are currently using an HSA eligible plan and/or thinking about switching to one? What HSA administrator do you use and what do you think about it? I might do some research on that end and make another post about which ones are the best in the future.
That’s it for HSA guys! Let me know if there are any other questions/concerns I failed to cover here and thanks for reading!