HDHP with HSA: Friend or foe?
This is a guest post from Joanna Lahey, an associate economics professor at the George H. W. Bush School of Government and Public Service and a faculty research fellow at the National Bureau of Economic Research. The opinions expressed in this post do not necessarily reflect those of the aforementioned institutions. This is the final article in her series on health insurance. Here are the first, second and third articles.
Remember way back when in my first post when we talked about what the “ideal” health insurance would look like given human beings' unfortunate tendency to moral hazard? Basically, the idea was that health insurance would not be complete: There would be strong cost-sharing early on, but it would protect people from a catastrophic loss of money. (Note: This is “ideal” only from a certain theoretical efficiency standpoint — there are many ways in which it is far from ideal.)
High Deductible Health Plans (HDHPs) follow that basic model. The idea is that the client is responsible for all health care costs up to a certain high deductible, at which point the insurance kicks in, either with a coinsurance amount or paying 100 percent, depending on the plan. Frequently preventive care is provided for free prior to meeting the deductible (and under the provisions of the Affordable Care Act, we will be seeing more free preventive care). The size of the deductible is what makes it a “High Deductible” plan. In 2013, the minimum deductible for a HDHP is $1,250 for a single participant plan and $2,500 for a family plan. There's also an out-of-pocket maximum requirement for in-network providers, $6,250 for a single participant and $12,500 for a family. So a single plan at the legal limits would force you to pay $1,250 of your medical expenses upfront, and then a percentage of any remaining expenses until you hit the $6,250 out-of-pocket limit, at which point they pay the rest. Each year these numbers reset and you have a new deductible to meet and a new out-of-pocket limit.
One benefit of these plans is that the monthly cost to you is going to be less than for a plan that has a lower deductible. Insurance companies believe that if you're responsible for 100 percent of the costs up to a high point you'll be more likely to only use medical care that is absolutely necessary and they'll be less likely to have to pay anything. So they can charge less.
But is that smaller monthly payment worth it? If you're healthy and do not anticipate needing any health care, and, if, in the unlikely event that you get hit by a falling piece of airplane equipment, you'd be able to cover the deductible and out-of-pocket limit, then these plans can be a good deal. If, however, you know you're going to need some health care, but still likely to come under the out-of-pocket maximum, or if you know you cannot afford the deductible, then it may be worth it to pay more each month in premiums for the greater protection from a regular plan. If you expect a large amount of medical expenses, it is important to sit down and compare all of your options; the HDHP may or may not fit into your plan.
All of that is just looking at the HDHP in isolation. What really makes HDHPs attractive to some folks, especially those with an eye on financial independence, is that they can be paired with a Health Savings Account, or HSA. Without the HDHP, you cannot put money in the HSA.
An HSA works as an additional tax-advantaged savings vehicle, similar to an IRA. Each year you (and/or your employer) put money into the HSA tax-free, up to $3,250 for single plans and $6,450 for family plans in 2013. For those 55 or older, there's also an additional $1,000 allowed as a catch-up contribution. You can invest that money just like you would invest an IRA or 401(k). The money that goes in does not count in your adjusted gross income (AGI). A few states still ask you to pay state income tax on the money you put in, so you would only be saving at the federal level.
Do not confuse a Health Savings Account (HSA) with a Flexible Spending Account (FSA). An FSA expires every year and the money you didn't spend goes back to the company. You don't get to keep it. Companies can be tricky about this. My health care FSA is called a “Health Spending Account” and has the same acronym as a Health Savings Account even though it is not the same thing.
What happens to the earnings of the money that you invest in an HSA? Withdrawals for qualified medical expenses are tax-free. Qualified medical expenses include what you pay for your health insurance itself — the premiums, co-payments, and co-insurance, as well as medical care not covered by your insurance, such as dental or vision. You can use your HSA for durable medical equipment, even glasses, but you cannot use it for over-the-counter pharmaceuticals. You can even use HSA money to pay for transportation to get medical care.
If you withdraw money for a reason other than a qualified medical expense, you must pay taxes on the earnings and a 20 percent penalty. That's higher than the 10 percent penalty on your IRA. However, if you are over the age of 65 or on disability, you only pay taxes on the earnings, not the 20 percent penalty if you withdraw the money for something other than a qualified medical expense.
HSA vs. IRA/401(k)
In some respects, an HSA is even more attractive than an IRA because income goes in tax-free and the earnings are not taxed, so long as you use the money for qualified medical care. If you wait to withdraw the money until you are 65, the HSA is close to functionally equivalent to an IRA. If you don't think you'll need retirement money until age 65, or if you plan to have medical expenses in the future (and who doesn't, these days?), then sticking the maximum amount of money in an HSA can be a savvy financial move.
However, HSA money is restricted: If it is not used for medical care, you pay a pretty high penalty until you hit the age limit. And the age limit is higher for an HSA than it is for most retirement money. If you think you're going to need that retirement money before age 65 for something other than medical expenses, an HSA may not be the best place to stash it.
If you've already maxed out your tax-advantaged savings vehicles, should you pick out the HDHP just so you can get the HSA? There's no single answer to that question. It will depend on your expected medical costs, your risk preferences, and the alternative plans that you have available. If you don't have a whole lot of extra cash each year, the HDHP with HSA can be a risky proposition, but if you don't have a whole lot of extra cash, then you won't be able to put much in the HSA anyway.
Do you have an HDHP with an HSA? Do you like it? If you've been considering a plan, what aspects have you been thinking about?