20 Aug Medical Costs Out of Control? Consider the Health Savings Account (HSA)
The recent meteoric rise in medical insurance premiums has encouraged us to look for ways to reduce the cost of medical care for our clients and small businesses that we counsel. Insurance companies can now use age as one of the factors to set premiums in most states; therefore, those between the ages of 50 and 64 (pre-Medicare eligible) are finding the biggest rate increases. Tobacco use is also factored in and can result in premiums that are up to 50% more than non-smokers.
One possible solution is to pair a high-deductible health plan with a Health Savings Account (or HSA). High-deductible health plans (HDHP) typically have lower premiums than traditional health insurance. They cover preventative care but nothing else until the deductible is met annually. The minimum annual deductible is $1350 for an individual and $2700 for a family in 2019, but can go much higher. Originally created back in 2003, the HSA was created to pair with sanctioned high-deductible health plan and can be used to cover unreimbursed medical costs. They can be funded either by the employee, the employer or a combination of the two. Note that the employer’s contributions are not taxable to the employee. In some respects, they act like an IRA but in many ways, they are superior. Here is a list of our top ten features and benefits:
1. Triple tax benefits:
Contributions are pretax, the HSA grows tax free and distributions for qualified medical expenses are not taxed. In 2019 the annual maximum contribution is currently $3500 if you are single and $7000 for families (plus an additional $1000/year if you are over age 55). With the tax law changes reducing the number of people who can itemize deductions, this is way to get preferential tax treatment of medical expenses. If you have already maxed out your retirement plan contributions and are looking to reduce your taxable income, then this is an excellent way to do so. Have sufficient cash flow not to tap the HSA for medical expenses? Even better! Maximize your contributions to the HSA annually and let it grow until you retire.
2. Not “Use it or Lose it”:
Unlike an employer Flexible Spending Account where you have to use all the funds each year, the HSA can grow – becoming a savings vehicle for future healthcare needs (such as in retirement). With average lifetime retirement out-of-pocket costs estimated at $260,000 for a couple, this could certainly come in handy. If you start the maximum contributions at age 55, you could have close to $80,000 set aside by age 65!
3. Covered expenses:
Tax-free distributions from an HSA can be made for medical plan deductibles, diagnostic services, prescription drugs, dental expenses, vision related costs (including prescription glasses), chiropractors, long-term care insurance premiums, LASIK surgery, and some nursing services. Remember: this is pre-tax!
4. Easy to set up and use:
Most local banks offer HSA accounts and provide you with a debit card to use when paying for medical expenses.
5. Non-Medical withdrawals
After age 65 the funds can be withdrawn for any reason without paying an additional penalty. You will, pay taxes on distributions used for non-medical expenses after age 65, much like you would on IRA distributions.
Non-medical withdrawals prior to age 65 are also treated much like those from a traditional IRA- you will pay ordinary income taxes on the amount withdrawn PLUS a 20% penalty. This penalty does not apply if the person dies or becomes disabled.
6. Healthy and Wealthy
HSA’s favor healthy individuals who don’t want to spend as much each month on their premiums and don’t anticipate large annual medical expenses. They are also well suited to wealthier individuals who can afford to take the risk of self-insuring in a high-deductible plan and get greater benefit from the tax advantages.
7. Quasi IRA:
For high-income earners and business owners and those who aren’t going to tap the HSA for current medical expenses, the funds in an HSA can be invested – just like an IRA. Currently only about 15% of HSA accounts are invested in anything other than a money market fund. However, for those who view this as a long-term savings vehicle there are certainly opportunities for growth. Look for a low-cost provider with access to inexpensive funds and ETF’s.
8. Only with HDHP
If you are covered by any other health plan that is not high-deductible, you can’t contribute to an HSA. This also applies to Medicare, since Medicare is not considered a high-deductible health plan.
Just like an IRA, it is important to establish a beneficiary for your HSA when you open the account. If your spouse is your beneficiary then the account can be transferred to them tax-free and retitled in their name when you die.
A non-spouse beneficiary is not treated as favorably. The account will be cashed out and the funds will be taxable to the non-spouse beneficiary.
Health Savings Accounts can be funded until April 15th (tax filing) for the previous year, which can be advantageous for small business owners who are managing their cash flow.