Most insured Americans have one of two healthcare plan types: an HMO (health maintenance organization) or PPO (preferred provider organization). Generally, people aim for a plan that strikes at balance between a low deductible and monthly premiums.
But with all the turbulence surrounding the Affordable Care Act (“Obamacare”), many Americans are considering a third option. This is the HDHP with HSA, or a high-deductible healthcare plan with health savings account.
These days, an HDHP with HSA can save you thousands of dollars every year. Unfortunately, because there are so many myths and misconceptions, many Americans shy away from the idea. “High deductibles? Are you crazy?” But it’s really not as bad as it sounds. Honest!
How Health Savings Accounts Work
First things first: do not confuse a “health savings account” with a “flexible spending account,” “health reimbursement account,” or “health spending account.” It’s especially easy with that last one, which has the same initials! The differences are beyond the scope of this article, but you should absolutely know that these are not the same thing.
A health savings account is exactly what it sounds like: a savings account that you can use to pay for healthcare-related expenses and costs. That includes deductibles. But it’s more than just a savings account. It comes with special benefits that make it extremely worthwhile, as well as certain restrictions that prevent you from exploiting it.
Note that an HSA is not a healthcare plan. It’s used in conjunction with a healthcare plan. You aren’t replacing your HMO or PPO with an HSA. Rather, if your HMO or PPO qualifies as an HDHP, then you become eligible to use an HSA with your plan.
The Benefits of a Health Savings Account
The major selling point is that you can contribute pre-tax dollars to an HSA. Contributions are tax-deductible, meaning they reduce your tax liability in the same way as 401(k) and IRA contributions. In short, putting money in your HSA means you pay less in taxes.
Not only that, but your HSA funds remain untaxed as long as you spend them on legitimate healthcare expenses. What counts as legitimate? You should consult your HSA details for specifics, but doctor visits, copays, coinsurance, deductibles, prescription and over-the-counter drugs, and eyecare are usually all legitimate.
Another huge benefit is that HSA funds roll over from year to year, distinguishing HSAs from flexible spending accounts. A typical FSA resets to zero at the end of the year, so you lose any money that you don’t spend. Some employers may even make contributions to your HSA throughout the year. This is free money!
And don’t forget that high-deductible healthcare plans have drastically lower monthly premiums compared to low- or medium-deductible healthcare plans. So much so that you usually come out ahead in terms of premium savings vs. deductible costs.
How to Use a Health Savings Account
When you’re eligible (see restrictions below), you can open up an HSA at any bank that supports such an account. Your employer may have a preferred bank. Once the account is opened, you’ll receive a debit card and possibly a method of checking your balance online.
Any time you need to pay for a healthcare-related expense, you can just swipe the debit card like any other card. After that, the funds will be deducted from your account. It doesn’t get much simpler than that.
The Restrictions of a Health Savings Account
In order to be eligible for an HSA in 2017, your healthcare plan must meet these IRS guidelines in order to be considered an HDHP:
- Individual annual deductible at least $1,300.
- Family annual deductible at least $2,600.
- Individual out-of-pocket maximum at least $6,550.
- Family out-of-pocket maximum at least $13,100.
If you want to withdraw from an HSA for any reason other than a qualified healthcare expense, the amount of your withdrawal will be taxed and you will incur an additional 10% penalty.
A handful of other restrictions apply. For example, you’re ineligible if you
- have an FSA or HRA alongside an HSA;
- are enrolled in Medicare, TRICARE, or TRICARE for Life;
- have received VA benefits in the past three months, except for preventive care, or if you have a disability rating from the VA;
- are eligible to be claimed as a tax dependent.
For more details, check out the IRS booklet on HSAs, MSAs, FSAs, and HRAs.
Lastly, there are annual contribution limits for HSAs. In 2017, the limits are
- $3,400 for individual plans (under 55 years old);
- $4,400 for individual plans (55 years old or over);
- $6,750 for family plans (under 55 years old);
- $7,750 for family plans (55 years old or over).
Note that you must prorate your HSA contributions for all the months you are ineligible for an HSA in the year. For example, if you are an individual under 55 years old and you were ineligible in January and February, then you can only contribute $3,400 x 10 / 12 = $2,833 to your HSA.
Is an HSA Best for You? How to Find Out
The biggest drawback to an HSA is the high-deductible plan requirement.
Most HDHPs require you to pay for most expenses out of pocket up to the deductible amount before the plan begins contributing, and even then you have to pay coinsurance until you hit the out-of-pocket maximum. After that, everything else is covered 100%. Details may vary from plan to plan, but this tends to be the structure.
But HDHP deductibles are offset by lower monthly premiums, which can save you money. Let’s look at a practical comparison using two plans that were offered to my family. One is a low-deductible health plan (LDHP), while the second is the type of HDHP we’ve been discussing.
- LDHP: $550 per month / $750 deductible / $2,000 out-of-pocket max / 20% co-insurance.
- HDHP: $300 per month / $2,500 deductible/ $5,000 out-of-pocket max / 20% co-insurance.
A very healthy person who never uses their insurance would end up spending $6,600 per year for the traditional low-deductible plan and $3,600 per year for the high-deductible plan. Not only do they save $3,000 in annual premiums with the high-deductible plan, but they also get to save thousands of pre-tax dollars in an HSA.
A very sick person who maxes out their insurance would end up spending $8,600 per year for the low-deductible plan or $8,600 per year for the high-deductible plan. But remember, the high-deductible plan can be paid for using pre-tax dollars! Paying $8,600 in the low-deductible scenario is approximately the same as $11,467 in pre-tax dollars. In this example, the HDHP is actually more cost-effective if you expect to reach the out-of-pocket maximum.
A typical person who uses some of their insurance, but not all of it, is a bit trickier to assess. For example, imagine an emergency room visit that costs $15,000. On the low-deductible plan, you may only need to pay a $200 copay. The high-deductible plan would require you to pay the full bill up to the deductible amount ($2,500), then 20% co-insurance on the remaining amount ($12,500 x 20% = $2,500). If this was your only medical expense all year, the first plan would cost $6,800 for the year whereas the second plan would cost $8,600.
And don’t forget that low-deductible plans tend to provide better coverage during the still-paying-deductible phase of healthcare. For example, my high-deductible plan option only starts covering diagnostic tests after I meet the deductible. My low-deductible plan option covers 100% of diagnostic tests even before meeting the deductible.
Comparing HSA and Non-HSA Plans
Okay, all the above requires a lot of math, number crunching, and time. Maybe you don’t have the will or wherewithal to do any of that. Isn’t there a tool out there that will crunch the numbers for you? As a matter of fact, yes!
A reddit user named HSASpreadsheetGuy created a Google spreadsheet that automatically compares the potential costs of a high-deductible plan with HSA versus a low-deductible plan. It also takes tax considerations into account. Only two plans can be compared at a time, but even so, it’s extremely useful. Here’s how to use it:
- Open the spreadsheet in Google Sheets.
- Go to File > Make a copy… to copy it to your own Google Drive.
- Fill out the spreadsheet sections: Low Deductible Health Plan, Annual FSA Contributions, High Deductible Health Plan, Annual HSA Contributions, and Taxes.
- Look at the resulting Effective Costs to see which one offers more value. The graph to the right is a great way to visualize the differences.
As you’ll see, the more you contribute to your HSA, the better a high-deductible plan becomes. That’s the beauty of an HSA: despite the high deductible, you’re paying with pre-tax dollars. So you end up saving a lot in the long run.
In short, an HDHP with HSA can be an excellent money-saver for someone who is very healthy or very sick, but only if you contribute as much as you can to your HSA. If you don’t have enough saved up to cover your out-of-pocket maximum at any given time, you may prefer a lower-deductible plan. If you’re neither healthy nor unhealthy, you may prefer a lower-deductible plan as well.
Remember: Keep Your Receipts
It’s one thing to fall victim to fraudulent tax returns. It’s another to commit tax fraud through misuse of your health savings account. Because HSAs are easy to abuse, you must be responsible with yours. Never use it for unqualified healthcare expenses. If the IRS audits you, you must be able to show proof of legitimate spending.
As such, any time you pay with your HSA debit card, you should always get a receipt. Whether that receipt is paper or digital doesn’t matter as long as you get one.
If you get a paper receipt, you should absolutely scan it as a PDF document. Plenty of tools exist for this, including free or paid mobile apps as well as physical scanners for your computer. Either way, just make sure you store those PDFs safely, and make sure you back them up!
The Secret Reason Why HSAs Rock
In addition to the above, there are two more things to know about HSAs.
First, you can invest HSA funds without paying tax on the earnings. In this sense, an HSA makes for a great retirement vehicle alongside a 401(k) and IRA. But it’s arguably even better, because it’s triple-tax-advantaged. You get to contribute pre-tax money, the investment earnings aren’t taxed, and you can make tax-free withdrawals on qualified health expenses.
Second, you can defer withdrawals for healthcare expenses to the future. Let’s say your doctor visit costs you $100 today. You can pay for it out of pocket, save the receipt, then make a $100 withdrawal from your HSA at any time in the future. There is no time limit between the time you incur a healthcare expense and when you can make a withdrawal for it.
Many financial-savvy folks will leave their contributions in their HSAs, invest them in the market, let them grow through compound interest, and make deferred withdrawals when they reach some future age, such as retirement. (The annual contribution limit means there’s an opportunity cost to making withdrawals. Remember that you can’t re-contribute that money later.)
If you plan to retire as early as you can, an HSA is an extremely effective investment tool. Some even suggest prioritizing it over your 401(k) and IRA after taking advantage of any company matching benefits. Not sure if you’re on track for retirement? See now with these nifty retirement calculators and tools.
Hopefully you can now see why HSAs can be amazing in the right circumstances. What do you think? Are you happy paying higher premiums for lower deductibles? Share your thoughts with us down in the comments!
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