Scrolling through Facebook the last few days, I’ve seen an alarming number of people re-posting the same misleading information about Health Savings Accounts (HSAs). See below:
If you don’t have knowledge or experience with HSAs, this post would probably succeed in scaring you to death. The good news is, this post is misleading…at best. It was likely written by someone who doesn’t understand how HSAs work or by someone whose intention was to deceive the reader (I’ll give the author of the post the benefit of the doubt and go with the former).
So what is an HSA, exactly?
Just because you have an HSA, doesn’t mean you are responsible for 100% of your healthcare costs. An HSA is simply a savings account you can contribute to on a tax-advantaged basis (more on that later) to help pay for out-of-pocket medical expenses until your deductible is met. There are certain requirements you need to fulfill to open an HSA, but to keep it simple, they are policies with a higher deductible and lower premiums than traditional health insurance plans.
Why would I want a higher deductible/HSA policy?
There are many advantages in opting for a higher deductible HSA policy. The main advantage is the lower monthly premiums. If you are a healthy individual who seldom goes to the doctor other than routine check-ups (which by the way, are covered prior to meeting your deductible even in HDHP plans), you would likely save a lot of money on a monthly basis if you choose this type of plan. Other advantages include:
- Pretax/tax deductible contributions – contributions to an HSA can be made through payroll deposits with pre-tax dollars, meaning, the contributions are not subject to federal income taxes. In most states, contributions are not subject to state income taxes (the exceptions are California, New Jersey and Alabama).
- Contributions from your employer – many employers make annual contributions to your HSA should you elect to sign up for that plan. Ask your HR administrator to walk you through their HSA plan details.
- Tax-free growth/withdrawals – you don’t lose the money contributed to an HSA if you don’t use it from year to year. In fact, you can actually invest money you contributed and it will grow tax free (much like an IRA or 401k retirement account). Additionally, you can withdraw money from your HSA tax free so long as withdrawals are used for qualified medical expenses.
- Convenience – when you setup an HSA, you should receive a debit card that is connected to your HSA. This debit card makes it easy to pay for medical expenses like visits to your doctor or prescriptions.
Ok, this sounds good. But what are the disadvantages of an HSA?
There definitely are disadvantages in opting for an HSA. Here are the major ones:
- Saving enough cash to meet your max out of pocket medical expenses – the savings from lower premiums might not be enough to cover medical costs to meet your deductible.
- Recordkeeping – you must have your records in order if you have an HSA in case you get audited by the IRS. This means keeping all receipts used for qualified medical expenses.
- Fees – as with any account you open, beware of any fees. Some financial institutions will charge a monthly or annual fee; be sure to read the fine print prior to opening up an HSA.
I’m still confused, can you just give me a real-life example?
Definitely! A few weeks ago, a friend of mine (let’s call him John) asked me if he should opt out of his current (traditional) PPO plan for an HSA-PPO plan his employer offered.
His current PPO plan deductible was $0 with a max out-of-pocket of $500. That’s a pretty good plan. But the portion of insurance premiums he was responsible for was $230/month (net of tax), or $2,760 every year. That’s a pretty steep price to pay before stepping foot inside a doctor’s office.
The HSA-PPO he was considering switching to had a deductible of $1,800 with a max out-of-pocket of $4,500. On the surface this doesn’t look like such a good deal. However, his employer covered the monthly insurance premiums AND would deposit $800/year into his HSA. Additionally, he could make contributions to his HSA on a tax-advantaged basis (see the example below).
In order to see which plan made sense, we ran two scenarios: a worst and best case scenario. The best case scenario assumes that John is healthy for the whole year (and therefore, made no HSA contributions) and only went to his doctor for an annual checkup (which is 100% covered as noted above). The worst case scenario we assumed that he has some health issues and ends up hitting his out-of-pocket max, but contributes $2,600 to his HSA.
Here are the results:
The results surprised me. Under both scenarios, John would save money utilizing the HSA plan his employer is offering to him. Under the best case scenario, John would save $3,560 per year (he would actually make $800 from his employer contributions) and under the worst case scenario, he would save $210.
John would be better off utilizing his HSA plan even under the worst case scenario because of his $650 tax savings. We estimated John’s marginal tax rate to be 25%, so his contributions of $2,600 only ended up costing him $1,950, indirectly lowering his medical costs.
This post is not to try and convince you to switch to an HSA plan, it’s simply to point out that HSAs are not this big, bad horrible idea that some politicians like to make it out to be. There are advantages and certainly disadvantages in choosing a plan that involves an HSA. As illustrated in the example above, it could save you thousands of dollars per year. If you are young and healthy, you should definitely consider an HSA plan to see if it will save you money.