High-deductible health plans (HDHPs) are growing in popularity, with several surveys indicating that 40-50% of employers now offer a HDHP, and that 20% of eligible employees opt for them. HDHP plans are often paired with a Health Savings Account, so that in this changing world of health care, it now becomes imperative to become familiar with high-deductible health plans and Health Savings Accounts.
Qualifications for opening a Health Savings Account
A Health Savings Account, or HSA, is a tax-advantaged medical savings account available to an individual enrolled in a high-deductible health plan. For the calendar year 2015, a high-deductible health plan is defined by the IRS to be a “health plan with an annual deductible that is not less than $1,300 for self-only coverage or $2,600 for family coverage, and the annual out-of-pocket expenses (deductible, co-payments, and other amounts, but not premiums) do not exceed $6,450 for self-only coverage or $12,900 for family coverage”.
Initially, one may have wondered why the IRS provided the definition of a high-deductible health plan, but when considering the tax advantages which come along with an associated HSA, it becomes clear why this is the case.
To be eligible to open an HSA the individual:
- must be covered under a high-deductible health plan on the first day of the month in which the individual wishes to open the health savings account.
- cannot be covered by any other plan, which is not a high-deductible health plan. –
- cannot have a general-purpose health FSA (a limited-purpose FSA for dental and vision expenses is however, allowed)
- cannot be enrolled in any part of Medicare or Tricare
- cannot be receiving Veteran’s health benefits currently or in the past 90 days.
- cannot be claimed as a dependent on another person’s tax return.
The HSA as a tax-advantaged retirement vehicle
The philosophy of an HSA is to provide the individual with a tax-favored space for their monies to spend on qualified medical expenses (www.irs.gov/publications/p502/index.html). The conditions imposed by the IRS stating eligibility and conditions which would bar an individual from opening an HSA are to prevent abuse of this perk, which is granted to users of a HDHP as their sole medical plan.
The HSA has been likened as a medical-IRA (Individual Retirement Account) due to its triple-tax advantaged structure: money may be contributed on a pre-tax basis, money grows tax-free, and for qualified medical expenses the money may be withdrawn without paying any taxes. Naturally one might ask what if an individual were to use monies for non-qualified medical expenses. Usually the custodian of an HSA does not enforce how the monies are spent, rather it is up to the individual to abide by the rules in the event of an IRS audit. However, if one does choose to use the funds for an unqualified expense, taxes will have to be paid on the amount withdrawn AND a 20% penalty will be assessed. The usual qualms with HSAs are that they have very narrow uses. It is a common criticism that HSAs pigeonhole hard-earned capital into limited-use categories. But while an individual on Medicare is not eligible for an HSA, the flip side is that after an individual reaches the age of 65, they may withdraw and use funds from the HSA without being assessed the 20% penalty (taxes however, still must be paid if it is for a non-qualified expense); hence the HSA functions like a medical-IRA. There are no income phase-out limits, making the HSA for certain individuals a more attractive retirement vehicle.
Uses and Strategy for Maintaining an HSA
HSAs offer many possible uses. In this section we describe a few features that are often overlooked.
1. Use pretax dollars for an upcoming qualified medical expense.
Suppose an individual has an upcoming office visit, or a scheduled surgery fast approaching. A person with an HSA may contribute to their HSA and use those pretax dollars to pay for the visit and surgery. As an aside: providers usually provide a discounted rate for cash payments that do not use the insurance plan. This is to save the provider the hassle of paperwork and waiting for the insurance company to compensate them accordingly. The downside is, however, that the expense will not count towards your deductible. When evaluating the bill, check to see if it is likely you will want the bill to count towards the deductible, or if you would prefer the discounted rate for paying completely in cash.
2. Invest monies through your HSA custodian
Depending on your choice of HSA custodian, you may be able to invest in funds rather than holding liquid cash. Different HSA custodians offer different fund selections, but most operate much the same way as a brokerage. It is important, however, to note that unlike liquid cash, investment products are not FDIC-insured so that it is possible to lose money when investing. In addition, money used to purchase funds detract from the account balance, so if one wishes to use funds to pay for an expense, one might have to first sell off the fund to obtain cash in the account.
3. Reimburse yourself for past qualified medical expenses.
One very powerful, yet relatively unknown feature of an HSA is that you can pay for a qualified medical expense out of pocket first, then reimburse yourself at a later date, provided the date the HSA was opened was prior to the date of the incurred expense. There is currently no statute of limitation for when you can reimburse yourself, so you can pay for the medical expense out of pocket first, while leaving your HSA monies invested, then years, even decades later, reimburse yourself with the hopefully now larger HSA balance. Naturally you can only reimburse yourself once for each expense. It is advisable to keep receipts, as this is proof to the IRS that the later withdrawal of monies relates to qualified medical expenses. As receipts tend to fade with time, one should have a spare photocopied receipt and perhaps electronic copies as well: a copy on a thumb drive or computer or a copy in the cloud.
4. Lower your tax burden
As monies contributed to the HSA are on a pre-tax basis, on the federal level and with most states (except California, New Jersey and Alabama), HSA contributions are not counted towards income. This can lower your tax burden much in the same way a 401(k) does. 5. Save towards retirement With improving technologies and better healthcare, life expectancy is projected to increase. With many Americans unable to fully retire, it may be prudent to consider preparing for retirement at an early age. With increased health care costs and increased medical expenses in old age, contribution to an HSA will surely be used either for medical expenses or for general expenses after the age of 65.
5. Save towards retirement
With improving technologies and better healthcare, life expectancy is projected to increase. With many Americans unable to fully retire, it may be prudent to consider preparing for retirement at an early age. With increased health care costs and increased medical expenses in old age, contribution to an HSA will surely be used either for medical expenses or for general expenses after the age of 65.
Charles is a Bay Area native despite a four year hiatus at Princeton University.