Many individuals are well aware that health care costs are risings and it is often the most expenses item in one’s retirement plan. However, very few individuals have implemented a strategy to handle these future expenses and are missing out on utilizing a key tool in preparing for this. A Health Savings Account (HSA) is a tool that I would strongly encourage one to consider using. I want to help you think through why you should or should not use an HSA and how you can implement both short-term and long-term strategies to be prepared for your future health care costs.
What is an HSA and Key Advantages
First, let us start by defining an HSA. An HSA is an account offered most commonly through an employer’s benefits package that allows you to be able to contribute via your paycheck for medical expenses. Now the HSA has a triple tax advantage that is very unusual and rare. This account was created and given these tax advantages in order to encourage people to save to help combat higher medical costs. First, when you take money from your paycheck and put it in an HSA it is not taxed. Second, you could potentially earn interest or invest your HSA in the stock and bond markets and it grows tax-free! Last, when you take a distribution from your HSA, it is a non-taxable event as long as it is used for medical expenses. Basically, if used correctly you will pay no federal taxes on your medical expenses. As of 2019, four states (New Jersey, California, Tennessee, and New Hampshire) do not duplicate the federal tax rules and you will potentially pay some state taxes.
Another huge advantage of an HSA account is that if you do not need the funds, you can leave it in the HSA account until you do need it. With a Flexible Spending Account (FSA), which is normally offered through an HMO or PPO health care plan, you will lose your contribution if you do not use them before the end of the year. Here is a link to learn more about an FSA account.
When it comes to the contributions to an HSA, you as an individual can put in $3,500 and if your family is using your health insurance you can put up to $7,000 per year for 2019. If you are over the age of 55, you can do an additional $1,000. Many employers often help contribute to their employees’ HSA plans to help them save for medical emergencies. This counts towards the total contribution limit. As an example, Jane has a high deductible health insurance plan through her employer. Her deductible is $3,000. Her employer put’s in $1,500 per year in her HSA on her behalf just for having it. Due to the annual limit of $3,500 she can contribute an additional $2,000 to the HSA account.
Requirements for HSA
Now in order to take advantage of this tax favorable account, you must follow the qualifying rules. First, in order to be able to contribute to an HSA plan, you must be enrolled in a health insurance high-deductible plan. If you signed up for health insurance through your employer you were probably given several options. A high deductible plan must have a deductible that is at least $1,350 per person and $2,700 family coverage. Often it is higher than this. A deductible is the expenses that you are solely responsible for each year before health insurance starts covering anything. Keep in mind there are other costs associated with medical expenses. Here is a link to a basic understanding of Health Insurance. Most employers have multiple health insurance options such as a Health Maintenance Organization (HMO) plan or a Preferred Provider Organization (PPO) plan or a high deductible plan. There are both pros and cons for each of these plans. Most HMO or PPO have lower deductable and lower co-pays than a typical high deductible health plan. However, the monthly premium for this better coverage is normally more expensive. So the question becomes do you want to pay more upfront for better coverage or pay less upfront and potentially larger medical bills in the future?
Is an HSA Right For You?
Even though the HSA offers great tax advantages, this decision really falls back to what type of health insurance coverage do you need. For those that have high medical expenses and are struggling with health issues, paying more upfront by utilizing an HMO or PPO with better coverages could be the better option. For those that are in good health and already have some savings for an emergency, these individuals can really take advantage of an HSA account. It really comes down to how much do you want to self-insure the risk through your own savings versus paying higher premiums to ensure potential lower health expenses later. Oftentimes, when you compare the premiums for an HMO or PPO plan, it is significantly higher cost. Switching to a high deductible plan can save you thousands of dollars per year in premiums.
How to Use Your HSA for the Short-Term
So how do you property utilize an HSA account to get the most value out of it? First, research your employer benefits to see if they will put free money in there for you! This alone can be a huge win for you.
Now for the short term use, let use Jane’s situation again. She has a $3,000 deductible with her health insurance plan through her employer. Her employer is putting in $1,500 a year into her HSA for her and she is putting in an additional $2,000 to max out the HSA. She also has a 3-month emergency fund in a high-yield savings account that can be used for all possible emergencies that comes up and not just a medical emergency. This is very important! If you take the funds out of the HSA for other non-medical emergencies, it will be taxed and charge you a 20% penalty. Inside of the HSA, the funds at default normally are inside a Money Market account. Money Market accounts are similar to a savings account. They are very safe but has low earning potential. Now Jane has a 3-month emergency fund plus $3,500 to meet her annual deductible and some medical expenses in her HSA if anything comes up that year. She has built layers of protections and taken advantage of tax rules to build a strong short term foundation.
How to Use Your HSA for Long Term Medical Expenses
But how do you use your HSA for long term care planning? Well, in many HSA accounts you can take the funds and place them in mutual funds that invest in stocks and bonds for the long term. Let’s move Jane forward a few years. As Jane continues to save to her HSA plan, she has not had any major medical issues. In a few years, she has saved $10,000 in her HSA. Now she can leave a nice amount in the Money Market inside of her HSA account to cover her annual deductable and then invest the rest into mutual funds to help grow. Furthermore, she can put her future contributions into these mutual funds. This allows for growth over time and often over a 10-30 year timeline one can save a significant amount. This can then be used for medical costs in retirement and all tax-free at the federal level!
Risk Associated with this Strategy
The risk with this strategy comes down to unexpected and high medical costs. This makes it vital that you have a solid emergency fund of 3-6 months outside of the HSA. Also, as you invest the extra beyond your deductible into mutual funds, you are subject to the risks of the market. Meaning you could lose money from the investments or be forced to sell out at a bad time. A good general guideline is you should not be investing in the stock market unless you are willing to leave the funds there for at least 10 years. The reward is that you are able to save a bunch of money tax-free at the federal level to help in retirement when you are very likely to have much higher medical costs.
Another thing to consider is even if you are able to save a good amount in your HSA before retirement, medical cost for long term care is very high. The average cost of living in a nursing home in America is $82,128 a year for a semi-private room and $92,376 a year for a private room. The normal long term stay in a nursing home is about 2.44 years but there are often several years of in-home care cost before moving to a nursing home. Medicaid can cover a portion of long term care but only once you meet many strict medical and financial requirements. Keep in mind, after age 65 you can apply for Medicare in order to help with health insurance costs as owning an individual health care policy will be very expensive.
If an illness occurs that requires a nursing home stay for over 3-5 years it could result in depleting all or a large portion that you have managed to save. This is why Long Term Care Insurance has been developed. Choosing to pay a premium today for a certain guaranteed coverage in the future is an option that takes some of the risks of spending down your net worth and places the risk on an insurance company. However, it comes at the cost of giving up your cash flow today. One great strategy to consider is utilizing your HSA to pay the Long Term Care Insurance premium. Based on your age you can take out a certain amount out of the HSA tax-free to pay for the premium on a Long Term Care policy. Using these tax-free dollars, to purchase long term care insurance can be a great way to help ensure against your future health care cost.
The reality of these decisions comes down to how much risk you want to place on your self based on the goals you want to achieve. I would encourage you to research utilizing your HSA through your employer and find a strategy for your health expenses. Or speak with a financial planner that will make a recommendation based on your goals, cash flow, and personal situation.
Director of Financial Planning