Your Guide to Health Savings Accounts
A health savings account is the retirement account for your health. It has a lot of great features, that when taken advantage of, will really put you in a good position in retirement.
What is a Health Savings Account
The health savings account is the trifecta of tax savings. Money that goes into an HSA is pre-tax money, like a 401k. This money can either come directly out of your paycheck so it skips taxes, or you can contribute the money on your own a deduct it on your taxes. Once the money is in the account, it becomes invested through investment options that you select. The money will continue to grow tax-free and can taken out tax-free. A health savings account is the only type of account that has this type of tax savings.
Unlike a flexible spending account, or FSA, an HSA never expires. An FSA must be used by the end of the year or the contributions will be lost. Not only will an HSA rollover from year-to-year but if you left your employer, you will take the health savings account with you.
Unlike most retirement plans, you can withdraw from a health savings account at any time. There is no penalty or taxes if you withdraw the money earlier than retirement.
An HSA must have a high-deductible health plan with it. You cannot open an HSA without one, and not all high-deductible health plans will allow a health savings account.
How Health Insurance Works
Health plans can structure deductibles in a couple of ways. If you are an individual, you will have to meet the individual deductible before the insurance steps in and helps to pay. If you are a family, and you are paying to cover that family, the insurance can have individual or aggregate deductibles. The individual deductible means each person in the family has their own deductible that they must meet. The aggregate deductible means anyone in the family can meet the deductible for the entire family. Under this method, you could spend the deductible money on yourself and then not have to pay a deductible when your spouse has health care expenses.
After the deductible we get coinsurance. The insurance company is not going to pickup the total cost once a deductible has been paid. They will pay for apart of it. The part that they do pay for is called coinsurance. Coinsurance is usually stated as a percentage, and it is the percentage that you will pay once the deductible has been paid.
For example, if your deductible is $1,000 and your coinsurance is 20%, you will pay $1,100 of a $1,500 health bill. You take your total bill, minus the $1,000 deductible, and you are left with $500. Of that $500, you will pay 20%, or $100 of it. This brings your total bill to $1,100. Once you have hit your deductible for the year, you won’t have to pay it again until next year. It does not restart for every health bill, it restarts every year. Once it has been used, health care expenses become cheaper for you for the rest of the year.
If you have already used your deductible for the year and you are debating on getting a medical procedure done in December or January, it would be cheaper to have it done in December.
The next feature of a health care plan that you must know is the out-of-pocket limit. The out-of-pocket limit is the maximum amount you can spend on healthcare in a given year, not including monthly premiums.
Once you have reached your out-of-pocket limit, the health care company will take over 100% of the expenses.
You had a procedure that costs $20,000, you have a $1,300 deductible, 20% coinsurance, and out-of-pocket maximum of $4,400. The most you would pay for this procedure is $4,400 plus any monthly premium charges.
You first subtract the deductible from the total amount because that must be paid first. $20,000 minus $1,300 gives you $18,700 left in charges. With the remaining charges, you figure out the amount you would pay with the coinsurance. 20% of $18,700 is $3,740. Your total charges are $1,300 plus $3,740 for a total bill of $5,040. This amount is more than your out-of-pocket maximum, so the total amount you would pay is $4,400. The insurance company would cover the remaining $640. Any more health care expenses for the rest of the year would also be covered in full by the health care provider.
Getting the Most Out of Your HSA
Each custodian comes with their own fee structure, which includes annual fees and setup fees, along with their own investment options. Investment options can be limited to a few certain funds or very wide and self-directed. If you do not like the custodian provided by your employer, don’t use that one, find your own and make your own contributions.
A quality, up-to-date breakdown of the top HSA custodians can be found at 20 Something Finance.
Unfortunately, it takes more than just finding the right custodian to maximize a health savings account.
Once you have a custodian, either provided by your employer or one you found yourself, you need to fund it. The contribution limits for your health savings account depends on the type of healthcare plan that you are on at your work. If you are on a single plan, where it just covers you, your 2019 contribution limit is $3,500. If, however, you’re on the family plan at work, your 2019 contribution limit is $7,000. These contribution limits are not aggregated with any other limits. So, if you invest in an IRA or Roth IRA, it doesn’t limit how much you can put into an HSA.
The idea behind a health savings account is to make these contributions, have them grow over the years, and then to cash them out in retirement. If you have a funded HSA, you can save your medical receipts over the years and submit them in retirement to get all the money back. This allows your contributions and earnings to get exponential growth over the years.
You cannot save or cash in any medical receipts from before you had a health savings account. This will also require you to pay out-of-pocket for your medical expenses up until that point. Again, you will have to pay your deductible and coinsurance, up the maximum out-of-pocket expense.
Being able to take advantage of the compounding of returns in an HSA is another great reason to have an emergency fund. If you do not have an emergency fund or find yourself tight on cash, it is still okay to use your health savings account immediately.
Once you are no longer have a high deductible health plan or you move onto Medicare, you can no longer contribute to an HSA. You can still use, move, and get the money out of your health savings account, but you will no longer be able to contribute.
How to Compare Company Health Plans
With a high deductible health plan, you are expected to lose money in the deductible portion. In this case, the deductible increased by $1,800. Not a huge deal, but it is more money that will need to be spent out of pocket before insurance kicks in. When comparing all this information, make sure you compare the single to single plan and the family to family plan.
The coinsurance and out-of-pocket maximum are the same in both plans. This is not always the case, but like I said, some employers really gear the high deductible plan to be a no-brainer.
To further sweeten the deal, the employer is going to contribute $1,000 annually into the health savings account. This benefit is not received through the traditional plan.
Once you have all your numbers figured out, it is best to run a few scenarios to make sure which plan is better. We like to know which plan comes out on top in the best-case scenario, worst-case scenario, and somewhere in between.
The best-case scenario would be $0 in medical expenses. In this case, the only money you are spending will be the annual premium amount. Clearly the high deductible plan is going to win here. Not only is the premium a lot cheaper, but they also kick in $1,000 annually into the plan.
The worst-case scenario would be $50,000. This is enough money that the annual out-of-pocket limit has been breached. For the traditional plan, the total cost would simply be the out-of-pocket limit plus the annual premium amount. In this case, $10,896 would be the total cost. For a high-deductible plan the total cost is $6,440. This is the out-of-pocket limit, plus the annual premium, minus the employer contribution.
We through in a few other scenarios just to make sure we have the right plan in place. As you can see, no matter what happens, good or bad, the high-deductible plan comes out on top. Now, this isn’t always the case. Some employers are not as generous with their high deductible plans as this one.
Looking at our scenarios, we can still see savings across the board, making the high deductible plan the way to go.
Health savings accounts are the only accounts that allow for triple tax savings. The contributions go in pre-tax, either through your employer or personally and with a tax deduction. The contributions and earnings will grow tax-free. Any distributions for qualified medical expenses also come out tax-free.
To really take advantage of the HSA benefits, you want to fund the accounts up to the yearly limits, and then invest those contributions and let them grow. Save all your medical receipts over the years and once you get into retirement, cash in those receipts for reimbursements.