As the cost of healthcare continues to rise, much remains to be done on demystifying the healthcare system to make it more transparent and less complicated – just ask anyone who has dealt with medical billing and health insurance lately. I’m sure I’m not the only one! It seems the “rules of engagement” change almost every time a new bill is generated.
Medical care is an important consideration in personal finance because the medical services we need and how we plan to fund those services or products directly impacts so many areas of our lives, especially our money. Failing to effectively plan ahead for healthcare considerations can, at worst, severely upend our lives, and at the very least, it will often derail our financial and other life goals. Many retirees find themselves going back to work simply to cover healthcare premiums or other costs, and it is no small wonder: it is estimated a couple age 65 in 2020 will spend approximately $295,000 (after tax) on healthcare over the course of their lives after retiring, according to the Fidelity Retiree Health Care Cost Estimate. Conversely, we younger folk are notorious for either not buying health insurance at all because we think we’re “always healthy and never need to go to the doctor,” or not buying enough or appropriate coverage.
Yet, one good and highly-useful investment vehicle has emerged in the recent past – the HSA, or health savings account, essentially a savings account that can be funded and used for eligible healthcare expenses. The U.S. Department of the Treasury notes HSAs were first established in 2003 as a tax-advantaged savings account for those with high-deductible health insurance plans.
Before we continue, it’s important to note HSAs are paired with and require a high-deductible health plan (HDHP), which you will need in order to implement any of the tips and tricks we explore in the rest of this column. HDHPs are gaining popularity and becoming more common as of late, for reasons we will examine.
HSAs feature a triple-tax benefit: money you contribute to your HSA can be written off on your taxes and thus reduce your income tax bill; money in your HSA grows and compounds (assuming it’s invested, and wisely) tax-free over time; and when HSA money is withdrawn for qualified medical expenses, no tax is paid on the withdrawal.
Also, after reaching age 65, you may take withdrawals for non-medical expenses, and the amount withdrawn is simply taxed at income tax rates, just like withdrawals from a traditional IRA (individual retirement account). Any non-medical expenses purchased using an HSA before age 65 incur a penalty in addition to regular income tax paid on the withdrawal amount.
By definition, high-deductible health plans require participants to pay 100 percent out-of-pocket for medical care until reaching the plan’s deductible; that is, the amount required to be spent by the individual or family before insurance begins paying a portion or all of medical costs.
As the name suggests, this deductible is much higher than a traditional health insurance plan. This benefits employers by saving them healthcare costs, which they can often pass on to employees in the form of lower health insurance premiums and perhaps even contributions to employees’ HSAs.
Assuming you have the cash reserves to self-insure against the worst-case scenario — namely, a calendar year of having to pay high healthcare costs up until reaching the out-of-pocket maximum when insurance pays 100 percent of qualified medical expenses — a HDHP with an HSA is a fantastic way to save money, build wealth, and save for healthcare down the road. Assuming you and/or your family are relatively healthy and don’t require much medical care throughout the year, a HDHP may save you substantial costs, especially considering many plans cover preventative care (annual checkups and exams, some prescriptions, etc.) entirely at no cost to you; that is, $0 out-of-pocket.
Many traditional health insurance plans (non-HDHP) require individuals and families to pay less out-of-pocket for the same medical care (for example, a $15 out-of-pocket copay for an office visit under traditional insurance versus a $100+ out-of-pocket bill for the same office visit under a HDHP), but the tradeoff for lower-cost office visits and medical care (with insurance picking up more of the tab) translates to substantially higher health insurance premiums, sometimes thousands of dollars more each year than a HDHP. This very high price is often paid simply to avoid setting aside some cash to pay for higher out-of-pocket costs with a higher deductible, if necessary.
It is very important to compare health insurance plans in addition to evaluating your overall health. Depending on the plans available to you, you may find the high-deductible plan results in a total net cost savings, all things considered. Even though it seems you are paying more for health care services out of pocket (and your deductible and out-of-pocket maximums are indeed higher), the lower cost of insurance premiums as well as possible employer contributions to your HSA may actually save money overall in a side-by-side comparison with the traditional, lower-deductible health insurance plan, making the HSA an attractive option. Thus, despite absorbing “risk” and potentially paying higher costs out-of-pocket during a year if you require a lot of medical care, you stand to reap substantial rewards over time, particularly if your HSA is invested.
This is what we discovered a number of years ago in our family. During annual enrollment, we switched to a high-deductible plan option with an HSA and have not looked back; our only regret is that we didn’t do it sooner and cash in on more savings. Yes, we’ve paid a number of expensive doctor’s office bills at 100 percent, but considering our massive savings on healthcare premiums and our ability to save and invest our HSA, the benefits far outweigh the short-term cost.
Actions you can take today, right now: compare plans. Determine if a high-deductible health plan (HDHP) with an HSA is a good option, based on risk, health, and cost savings. It would be wise to consult a financial advisor if you’re not comfortable comparing or crunching the numbers yourself. If or when you have an HSA, consider contributing, even maxing-out your yearly authorized HSA contributions if you’re able (For 2021: $3600 maximum contribution for individuals, and $7200 maximum for families; both maximums must also account for employer contributions).
Ensure you’re completely out of debt (except a mortgage) before you contribute to an HSA. Also, strongly consider investing it if you can (if you’re not immediately or soon dependent on your HSA for healthcare costs), and watch it grow! If your time horizon is long, I recommend a simple low-cost index mutual fund that tracks the S&P 500 Index, or a total stock market index fund. Again, a financial advisor can be very helpful regarding HSA investment allocation, particularly if you are nearing retirement age.
Our best and final hack requires a little record-keeping, but nothing difficult. Instead of using our HSA debit card to pay for medical expenses or reimbursing ourselves from our HSA immediately for eligible healthcare expenses we pay out-of-pocket, we save our receipts for these expenses, along with supporting documentation (insurance explanation of benefits, itemized medical bill, etc.). Since no limitation exists on when we can withdraw money spent on eligible medical expenses, we are allowing our invested HSA to compound over time using the money we could withdraw now, but choose not to: that $100 for a doctor’s office visit left untouched in your HSA to compound could hypothetically, depending on market returns, be worth $700-800 in 30 years.
In closing, high-deductible health plans with HSAs are not for everyone; it’s critical to weigh the costs and benefits. Above all, have a plan for healthcare at every point in your life, especially approaching or in retirement. If you have a HDHP, you may find it helpful to get estimates from medical providers on costs and go to in-network providers for the best discounts; careful planning and budgeting pays off.
Lastly, it’s alright to use HSA funds, especially if you have a true emergency or unexpected medical bills; better an HSA than going into debt. However, if you can afford not to touch it, it will only continue to compound over time.
Luke Miller is passionate about helping others succeed in their finances, careers, and lives. A fourth-generation aviator, he is a pilot for a Seattle-based major airline. Luke and his wife live locally in Enumclaw. This article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice.
