Much has been changing in the world of health care here in the US. While the opinions on these changes vary widely, one thing I can say with some certainty is that the number of people having access to and choosing High-Deductible Health Insurance Plans is likely to increase. These plans basically allow you to “self-insure” for part of your health care costs in exchange for lower premiums.
In the past, most health insurance plans came with very low deductibles and paid for most every medical cost beyond them.
Those were the good old days.
As medical costs have skyrocketed, so have the insurance premiums required to provide such comprehensive coverage. Now, by having the insured (that is to say, you) shoulder some of the risk, the high-deductible plans are able to offer insurance against catastrophic illness and injury at more affordable rates. In exchange the insured (you, again!) is responsible for paying the first medical bills out of pocket each year, typically $5-10,000. To make this a bit more affordable and attractive, Health Savings Accounts (HSAs) were created to help handle these out-of-pocket expenses.
Basically, these are like an IRA for your medical bills and, as we’ll see, the way they’ve been constructed creates some very interesting opportunities.
With an HSA, as of 2014, you can set aside up to $3300 for an individual and $6550 for a family each year. Like an IRA, you can fund this account with pre-tax money. Or, put another way, your contribution is tax-deductible. You can open an HSA regardless of your income or other tax-advantaged accounts to which you might also be contributing.
Here are some key points:
- You must be covered with a High-Deductible Health Insurance Plan to have an HSA.
- Your contributions are tax deductible.
- If you use a payroll deduction plan through your employer, your contribution is also free of Social Security and Medicare taxes.
- You can withdraw the money to pay qualified medical expenses anytime, tax and penalty free.
- Any money you don’t spend is carried forward to be used when you need it.
- Qualified medical expenses include dental and vision, things often not part of health care insurance plans these days.
- You can use your HSA to pay the health care costs of your spouse and dependents, even if they are not covered by your insurance plan.
- If you withdraw the money for reasons other than medical expenses, it is subject to tax and a 20% penalty.
- Unless you are age 65 or over, or if you become permanently disabled; in which case you’ll owe only the tax due.
- When you die, your spouse will inherit your HSA and it will become his or hers with all the same benefits.
- For heirs other than spouses, it reverts to ordinary income and is taxed accordingly.
This is also a good moment to point out that, while HSAs are often confused with FSAs (Flexible Spending Accounts), they are not at all the same. The key difference is that with an FSA, any money you don’t spend in the year you fund the account is forfeited. The money in your HSA, and anything it earns, remains yours until you use it.
What we have here is a very useful tool, and one well worth funding for those who have access to it. But as promised above and as might be said on a late-night TV infomercial, there’s more…
Remember how I said this creates some very interesting opportunities? Some additional key points:
- You are not required to pay your medical bills with your HSA.
- If you so choose, you can pay your medical bills out-of-pocket and just let your HSA grow.
- As long as you save your medical receipts, you can withdraw money from your HSA tax and penalty free anytime to cover them. Even years later.
- While those who plan to use this money to pay current medical bills are best served (as with all money you plan to spend in the short-term) keeping it in an FDIC insured savings account, that’s not the only option.
- You can choose to invest your HSA anywhere. Such as in index funds like VTSAX.
- Once you reach the age of 65, you can withdraw your HSA for any purpose penalty free, although you will owe taxes on the withdrawal unless you use it for medical expenses.
As we sit back and ponder all this, an interesting option occurs. Suppose we fully funded our HSA and invested the money in low-cost index funds? Then we’d pay our actual medical expenses out-of-pocket, carefully saving our receipts, while letting the HSA grow and compound tax-free over the decades.
In effect, we’d have a Roth IRA in the sense that withdrawals are tax-free and a regular IRA in the sense that we got to deduct our contributions to it. The best of both worlds.
If we ever needed the money for medical expenses, it would still be there. But if not, it would grow tax free to a potentially much larger amount. When we are ready, we can pull out our receipts and reimburse ourselves tax-free from our HSA, leaving any balance for future use. And should we be fortunate enough to remain healthy, after age 65 we can take it out to spend as we please, just as with our IRA and 401K accounts, paying only the taxes then due.
And how about those nasty RMDs discussed in Part XXIV? Well, so far the law has been silent on this point. It could go either way. Keep your fingers crossed.
The bottom line is that anyone using a high-deductible insurance plan should fund an HSA. The benefits are simply too good to ignore.
Once you do, if you choose, you can turn it into an exceptionally powerful investment tool. I suggest you do.
Addendum 1:
My pal, The Mad Fientist, calls this “Hacking your HSA” and he has created this cool graphic illustrating it:
I suggest you click anywhere on the above to see his full post describing the process,
as well as his post The Ultimate Retirement Account.
