A New Way to Save on Premiums
Health savings accounts will cut your taxes, too.
By Mary Beth Franklin, Senior Editor
Kimberly Lankford, Contributing Editor
From Kiplinger's Personal Finance magazine, November 2004
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Looking for relief from soaring health-insurance costs? You just might find it this fall as more employers -- including the federal government -- begin offering a new choice: a high-deductible policy tied to a health savings account (HSA). The high-deductible policy will cut your monthly premiums while the savings account will cut your taxes.
If your employer doesn't offer the option during this year's open season, you might want to start agitating to have it added ASAP. If you're self-employed and buy insurance on your own, you may already have a high-deductible policy because anything else can be prohibitively expensive. If so, you may open a tax-saving HSA on your own.
The plans became available this past January, but you're forgiven if you know little about them. Employers are just beginning to build them into benefit plans. By this time next year, though, HSAs will be widespread. A survey of nearly 1,000 employers, conducted by Mercer Human Resource Consulting, found that three-fourths of them expect to offer HSAs for 2006. "We're looking at a major market change unlike anything we have seen before," predicts Linda Havlin of Mercer's health-care and group-benefits consulting practice.
Whether you'll face the HSA choice within the next few weeks or later, you need to understand how the plans work to know whether they're the best option for you and your family.
The basics
HSAs are the latest in the move toward "consumer driven" health care. The theory behind the concept: The more of your own money that you have to spend, the more likely you are to make financially smart decisions, such as skipping a visit to an emergency room for a minor problem or choosing generic rather than brand-name drugs. The high-deductible policy means paying more out of pocket before your insurance kicks in; the tax-favored savings account holds the money to pay those bills.
To qualify for an HSA, you must be under age 65 and purchase a policy with an annual deductible of at least $1,000 for an individual or $2,000 for a family. This policy must be your only health insurance. Once the policy is in place, you may set up an HSA and contribute up to the amount of your policy's deductible -- to a maximum of $2,600 for singles and $5,150 for families. If you are 55 or older by the end of the year, you can contribute $500 more than the policy deductible.
Money you put into the account can be deducted on your tax return -- whether or not you itemize deductions. In the lowest tax bracket, a $1,000 contribution will save you $100 in federal income tax; in the top tax bracket, a $5,000 contribution will save $1,750. You'll get state income-tax savings, too, and if your HSA is part of a group plan, your deposits will also dodge the 7.65% social security and medicare tax. Another potential plus of group HSAs: Employers can contribute pretax money to your account, just as they put money into your 401(k). Because a high-deductible policy saves the employer money, such contributions let it share the wealth.
Earnings in an HSA grow tax-free, just as in a 401(k) or IRA. But unlike retirement plans, you can dip into an HSA at any age -- tax-free -- to pay for medical expenses, including your deductible and co-payments and many charges that typically aren't covered by health insurance, such as over-the-counter drugs, vision and dental care (even orthodontia and laser eye surgery), long-term-care insurance premiums and future medigap premiums.
"The HSA is the most tax-efficient investment vehicle available," says Jon Kessler, chairman of WageWorks, an employee-benefits consulting firm in San Mateo, Cal. "Money is not taxed on the way in. It grows tax-deferred. And if used for medical purposes, it's not taxed on the way out."
Unlike flexible-spending accounts (FSAs) used to pay for health-care expenses, HSAs allow unspent money to be rolled over from one year to the next, potentially building up a tax-free stash of savings. The money doesn't have to be used for health care. But you will owe income tax on earnings if funds are withdrawn for other purposes, and a 10% penalty will be imposed on any nonqualified withdrawal before age 65. (After 65, the money may be withdrawn penalty-free for any purpose, but earnings not used to pay medical bills will be taxed.)
Speaking of FSAs, you can't have an HSA if you use a flexible-spending account to pay health-care costs with pretax dollars or if you have other medical coverage (say, through a spouse's policy). However, if your FSA restricts reimbursements to wellness care (such as annual physicals) and vision and dental care, you can have an HSA, too.
Savings in action
Bill Lomel, who owns a roofing company in Atlanta, is an early convert. "I was just so discouraged about the cost of health insurance," he says. He was already struggling to pay $750 a month for insurance for himself and his three children when he got a notice that the cost of the group policy for his employees was going to soar. "I thought, There's no way I can charge enough for anything in my business to cover that expense. I want to offer good competitive benefits to my employees, but I can't."
Now, maybe he can. He started by opening an account for his own family. After searching eHealthInsurance.com for HSA-eligible policies, he selected one from Golden Rule that cost just $250 per month. The deductible is a hefty $5,000 per year, but Lomel is saving $6,000 a year in premiums and investing almost that much in a health savings account. He'll use the HSA to pay extra out-of-pocket expenses and to save for future costs.
"Basically it's paid back in less than a year," he says. "If I don't use it, I can roll the money into retirement dollars. I never lose."
Even though the deductible is higher, Lomel would rather save the money on premiums and have more control over his medical expenses. "We have no major health problems, and I don't think it's important to pay tons of money for insurance to cover doctors' visits. We have insurance for the big things," he says. "If I don't use it, I get to keep it instead of having the money go into the system."
Lomel was so impressed with his experience that he plans to fund HSAs for his 25 employees in lieu of offering group health insurance that was costing him up to $1,100 per month for each of his employees' families. By switching to high-deductible policies, he'll save thousands of dollars in monthly premiums. He plans to use some of that money to contribute to his employees' HSAs, which they can then use for out-of-pocket costs.
Savvy consumers
Other small businesses see HSAs as a way not only to save money on health insurance, but also to turn their employees into discriminating health-care consumers. Choosing health-care services wisely saves the consumer money and reduces the company's overall utilization of health insurance, which could minimize future rate hikes.
First National Bank of Orwell, in Vermont, offers employees a family health-insurance plan with a $4,500 deductible. The bank uses the money it saves on premiums to contribute $3,250 to each employee's HSA. Theoretically, the employee's maximum out-of-pocket expense would be $1,250 -- the gap between the HSA and the deductible -- before the insurance takes over. That may sound like a lot, but it's really not when compared with a traditional health-insurance plan that has a $500 deductible and a 20% co-pay. With such a plan, an employee who racks up $4,500 in health-care costs would be responsible for $1,300 including the first $500 and 20% of the remaining $4,000.
"What I like about HSAs is that they force consumers to be invested in their health care," says First National Bank president Mark Young. He notes that when an employee's son injured his ankle, the doctor diagnosed a sprain and prescribed a boot and crutches, which his office could supply for a fee. The employee decided to buy the boot at a discount drugstore and borrow crutches from a neighbor. "Therein lies the benefit of an HSA," says Young. "If consumers don't spend the money, they can carry it forward to the next year."
Some critics worry that employees might skip needed medical care in order to save money. So when the state of Arkansas rolled out its new health-care options this fall for state employees and teachers, it included a free wellness benefit that covers one annual checkup with its high-deductible health-insurance policy and HSA. Arkansas is not contributing to employees' HSAs, but the state requires all participants to contribute at least $20 a month to pay out-of-pocket medical expenses.
Prime candidates
So, if given the option, should you jump on the HSA bandwagon? It depends on your health, your cash flow and how much your employer is kicking in. "It really is going to demand a careful cost-benefit analysis," says Victoria Craig Bunce, director of research and policy for the Council for Affordable Health Insurance.
Look through your previous year's medical expenses and estimate how much money you spent on premiums, co-payments and deductibles. Then compare it to the lower-premium cost of a high-deductible health plan and tax savings from an HSA.
A calculator at eHealthInsurance.com lets you estimate your annual tax savings from contributing to an HSA and the potential for long-term savings if you allow some money to accumulate each year. For example, if you leave $2,000 a year in your HSA for 20 years, and assume a modest 4% annual return on your investment, you end up with more than $61,000 in your account.
Young, healthy, single individuals and others with few medical expenses are ideal candidates for HSAs, particularly if their employer contributes to the account, says Paul Devore, chief executive officer of Financial Management Services in Encino, Cal. The money can accumulate on a tax-deferred basis for years until needed.
Michael Kitces, financial-planning director for Pinnacle Advisory Group in Columbia, Md., says higher-income workers of any age who can afford to cover medical expenses with other savings, rather than tapping their HSAs, could also benefit. Their HSAs can serve as another source of tax-deferred savings for retirement.
Depending on the specific details of the insurance policy and employer contributions to the HSA, those in poor health or without excess cash flow will probably be no worse off if they choose an HSA option, although they may end up spending all the money in their account each year.
On your own
For many self-employed people, early retirees and part-timers without benefits at work, an HSA will often prove the best choice. That's what Carl Blachowicz discovered when his wife, Debbie, retired from AT&T. As the owner of a one-man auto-repair business in Orlando, Carl didn't worry about insurance as long as Debbie was working: The couple paid about $80 a month for coverage for themselves and their two children. But when Debbie retired, the premium would have jumped to more than $1,200 to stay on the AT&T policy.
Then Blachowicz discovered a better way to protect the family. Debbie stayed on the AT&T policy -- for $440 a month -- while Carl and the kids shifted to a policy from Assurant Health that had a $5,000 deductible. Premiums cost $230 per month. Most of the savings goes into an HSA.
HSA contributions lower the family's tax bill, and because Carl is self-employed, he can also deduct 100% of his premiums. He currently keeps the HSA money in Assurant's fixed-rate account, which is earning 3% per year, and will switch to an investment account once he builds a bigger balance. "It's one of the better things I've done since I've been in business," he says.
--Research: Amy Esbenshade
SHOPPING SMART
In search of the right HSA
Companies that offer an HSA option will have chosen the insurance company and the home for the savings account for you. If you're shopping for a plan yourself, check out the HSA Insider for companies that write HSA-eligible policies. Assurant Health, Golden Rule and several Blue Cross and Blue Shield plans have already introduced HSA-eligible policies, and more insurers are expected to come on board in the next few months. You can get quotes for HSAs in most states through eHealthInsurance.com. (One caveat: If you're buying the insurance on your own, insurers may be able to reject you based on your medical condition -- just as they can do with any other individual health insurance. The rules vary by state.)
Once you have narrowed your policy choices, shop for the savings account. Some insurers offer the account as part of a package; others just sell insurance and you set up the HSA with a bank or financial institution. Currently, most companies limit your investment options to fixed-rate accounts, but a few let you invest in mutual funds, which could be a good choice if you plan to keep the money in the account for the long haul. If HSAs catch on with employees and balances grow, mutual fund companies will probably begin offering HSAs, and it's likely that employers will introduce savings accounts with options similar to the investment choices inside 401(k)s.