The HSA perspective
KJ: The purpose of insurance is to help cover catastrophic events and not to make you whole in EVERY situation (particularly with small losses). That’s the theme of having a Health Savings Account (also known as simply an HSA). You are transferring some of the risk and payment for medical costs onto yourself from the insurance company in exchange for a nice tax break and reduced monthly premiums. If you set aside what you would have paid in premiums under the alternative health insurance plan into your health savings account, then you will often make it out way ahead.
Let’s continue with a brief introduction from Investopedia.com on what a Health Savings Account (HSA) is:
“An account created for individuals who are covered under high-deductible health plans (HDHPs) to save for medical expenses that HDHPs do not cover. Contributions are made into the account by the individual or the individual’s employer and are limited to a maximum amount each year. The contributions are invested over time and can be used to pay for qualified medical expenses, which include most medical care such as dental, vision and over-the-counter drugs.”
An HSA is essentially a special type of medical savings account.
How do we use the HSA?
We save a set amount each month to the HSA and cover all of our medical expenses incurred throughout the year from our monthly budget (without tapping into the HSA funds), which allows us to maximize the tax-deferred nature of the HSA for a long period of time. If and when we do use the funds for qualified medical expenses, then we do not pay income taxes. Plus, once we turn 65, we don’t even have to use the money for medical expenses in order to avoid the 20% penalty (read, you still have to pay income taxes on the funds if not used for qualified medical expenses). This allows us to treat it more like a Traditional IRA than anything else, but we have the added benefit of never having to pay FICA taxes (Social Security or Medicare payroll taxes) on the money if your employer allows you to use payroll deductions!
It’s not easy to get used to
Believe me, the health savings account is not without its challenges. It is difficult to get used to. You have higher out of pocket expenses (no cheap copays anymore), and it can make planning for medical items a little bit more challenging. What it does teach you is how much that doctor visit really costs since your out of pocket is closer to $70-$100 each visit compared to a $30 or $40 copay. But for the young, healthy, and wealthy (we’re two of those and working hard on the third), the HSA is a great tool once you get past the initial sticker shock of a doctor visit. HSA-friendly medical plans have monthly premiums that are typically far cheaper, so if you have a good personal finance software tool (see also Budgeting: a very good place to start) to help you manage your expenses, then you should seriously consider the HSA as a medical and supplemental retirement savings option.
AJ: Using an HSA has been a real challenge for me. I plan weeks and month down to the actualized penny we spend and not knowing how much it will cost to visit a doctor has been frustrating at times. However, the overall saving and tax benefits cannot be refuted. Below is a table Kirby created using arbitrary insurance costs in comparison to an HSA that helped me understand why it made more sense for us.
KJ: This chart illustrates the importance of “doing the math.” Both scenarios seem the same, right? WRONG! In fact, under the HSA enabled plan, if you contributed the doctor visit costs and the prescription costs to an HSA and you are a married couple making between $17,400 and $70,700 in 2012 (in the 15% income tax bracket), it could yield a tax savings of about $170 compared to the non-HSA enabled plan. If you are a married couple making between $70,700 and $142,700 in 2012 (in the 25% income tax bracket), it could yield a tax savings of about $250!(2) You can easily see how an HSA can add up and be a great tool. Your medical coverage may be substantially different in terms of premium, deductible, copay, etc., so put pen to paper to calculate your expenses (doctors, prescriptions, premiums).
Key characteristics of the HSA
1) You can take advantage of this additional savings vehicle if you are covered by a high-deductible health plan (HDHP) (minimum deductible of $1,200 for individuals and $2,400 for families). If you fall in that camp like my wife and I do, then you can open up an HSA (you may be restricted to the particular bank/institution that your company uses).
2) Contributions in the current year are not subject to EITHER federal income taxes OR payroll FICA taxes (Social Security or Medicare – if your employer offers payroll deductions for contributions). Compare this to a Traditional IRA or a regular 401(K) where you don’t have to pay current federal income taxes, but you still have to pay payroll taxes (currently totals 5.65% for most households, but has been around 7.65% in recent years).
3) Distributions used for qualified medical expenses are not subject to income taxes.
4) You can sock away $3,100 per individual or $6,250 for a family plan for 2012 and you can make additional contributions of $1,000 if you are over the age of 55.
5) Be aware that distributions from the HSA (if under the age of 65) that are not used for medical expenses are subject to income taxes and a 20% penalty. For more information, see the IRS publication on HSAs referenced below. (1)
6) Money in an HSA can roll over from year to year, but money in a FSA (Flexible Spending Account) is a use it or lose it scenario. It is one of the other great benefits of an HSA that it doesn’t have to be used in the year you make a contribution (or even in the following 5 or 10 years)!
Check with your HR department if you qualify, and start saving today!
(2) Including savings from FICA taxes.
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