Enrollment period for 2014 has come and gone. If you are like many workers in the U.S. you probably noticed changes in your health care benefit offerings. For the first time in a long time, many workers are weighing their options for health care coverage as high deductible health plans with health savings accounts are becoming more the “norm” for health care benefits. As health care continues to evolve and take shape, employers and employees are adapting to keep pace.
In an effort to reduce costs in response to the Affordable Care Act (ACA) and increase employees’ engagement in their own health care decision making, employers across the country are beginning to shift their focus from the traditional health care plans (HMO/PPO) to high deductible health plans (HDHP) coupled with health savings accounts (HSA). According to a 2013 survey on the ACA’s impact on employer sponsored health care, one in four organizations (24.5%) is increasing their emphasis on an HDHP with an HSA, while an additional 14.3% are assessing the feasibility of adding one. If you have not yet been affected by the changing health care landscape, we anticipate you may begin feeling the impact in the coming years as we fully expect to see an increase in companies’ emphasis on HDHPs and HSAs continue.
HSA AND HDHP Defined
HSAs were established in 2003 to allow individuals covered under an HDHP to save money for qualified medical expenses in a tax preferred manner. Only those covered by an HDHP are eligible to open and contribute to an HSA. Money saved to an HSA has the potential for a triple tax benefit –savings are tax deductible today (as a pre-tax contribution to an employer sponsored plan), earnings on your invested savings within the HSA are tax-deferred, and distributions can be taken out tax-free at any point in the future if used for qualified medical expenses. HDHPs have a higher deductible than traditional health care plans with a maximum limit on the combined deductible and any out of pocket expenses paid for covered medical expenses. For 2014, an HDHP is defined as a health plan with an annual minimum deductible of $1,250 (for individuals); $2,500 (for families), and maximum out-of-pocket amounts (not including premiums) of $6,350 (for individuals); $12,700 (for families).
The basics: What are the benefits to an HSA?
Being covered by an HDHP typically means you are subject to a lower annual premium, but the higher deductible means you are also more financially responsible for your out of pocket medical costs. While more of the initial financial burden rests on your shoulders with an HDHP, the IRS does provide certain benefits for establishing and funding an HSA which can be used to pay for covered medical costs today or in the future. Some of these benefits include:
- Contributions to an HSA can be made on a pre-tax basis. If you contribute after-tax dollars, you can claim a tax deduction for contributions you make to your HSA, even if you don’t itemize your deductions.
- Contributions made on your behalf by your employer may be excluded from gross income.
- The contributions made to your HSA roll over from year to year – meaning contributions are not lost at year end as with a Flexible Spending Account – the savings in your HSA are yours until you use it.
- Interest or earnings on the assets in your HSA grow tax-deferred
- Distributions may be tax free if used to pay for qualified medical expenses. Distributions for anything other than qualified medical expenses will be subject to a 20% penalty if withdrawn prior to age 65. If you use the savings in your HSA after age 65 for anything other than qualified medical expenses, you will not be subject to the 20% penalty tax, but the entire distribution will be treated as ordinary income (taxed at your ordinary income tax rates).
- Your HSA is portable, meaning it is transferrable if you leave or change employers.
- Because money saved to your HSA rolls over each year and is portable, it can be used as an additional source of tax-deferred retirement savings (more on this later).
- There are no income phase-outs prohibiting one’s ability to contribute to an HSA. The only prerequisites to contributing to an HSA are the presence of an HDHP, and you must be under age 65. See chart below for contribution limit details.
2014 HSA Contribution Limits
HSA contribution limit(employer + employee) Individual: $3,300 Family: $6,550 HSA catch-up contributions (age 55+) $1,000
Making the decision: HSA or traditional health plan?
High deductible health plans typically equate to lower premiums, but higher out of pocket expenses and deductibles. When it comes to deciding whether or not an HDHP and HSA works well for your situation, your decision should consider the numbers as well as the mental shift it will take to move away from a traditional copay arrangement.
Along with lower premiums, many companies offer incentives to increase employee participation in these lower cost plans. Some may offer “seed money” for first time enrollees, where they contribute a specified one-time amount when an employee enrolls in the HSA. In addition, many companies offer an ongoing matching contribution up to a specified amount if the employee is contributing to the HSA. While each company’s plan is different, know that you could be walking away from “free money” if your employer is willing to match contributions on your behalf and you choose not to participate.
Assume you are single, healthy, and do not expect to incur high medical costs this year. An HSA may seem like a no-brainer when you consider that you will have lower premiums, tax-deductible contributions, tax-deferred gains on the growth within the HSA, and tax-free distributions if used for medical expenses. Add in employer contributions on your behalf and this seems like a home-run.
Unfortunately, not all situations are as simple and clear as the scenario above. What about a more established family whose medical forecast for the year may be a little more unpredictable? Consider the following example.
John Client and his wife, Jane, have always participated in John’s group health insurance at work, and have enjoyed the benefits and security they feel they have received through the Traditional Health Plan. They pay a monthly premium and are subject to copay costs each time they go to the doctor. They have never questioned their coverage until last year, when they received a notice from John’s company that premiums were increasing for the Traditional Health Plan and the company was introducing an HDHP/HSA option with a first-time enrollment employer contribution, as well as an ongoing matching contribution. For the first time in years, John and Jane are considering a different type of health care plan due to the increased monthly premiums of the traditional plan.
Traditional Health Plan (PPO)
Monthly premium: $761 $443 In-networkdeductible $600 individual /$1,200 family $1,500 individual /$3,000 family Copay $25 per visit N/A Out of Pocket Max(in-network) $2,000 individual / $4,000 family $3,500 individual /$7,000 family First-time Enrollment Employer Contribution N/A $1,000 Employer Annual Matching Contribution N/A Up to $1,000 for employee contributions
*Under an HSA, participants may not be subject to a copay for doctor visits. However, HSA participants still receive a negotiated reduction in costs for visits under their HDHP. This means that you are not subject to full costs as if uninsured, but rather a discounted rate for your care under the HDHP’s negotiated rate. By seeing the negotiated costs, HSA participants are more aware and in control of the care they are receiving and the costs associated with it.
Because John and Jane Client are over age 55, they are eligible to contribute an additional $1,000 to the HSA above the annual contribution limit of $6,550 for families in 2014. That is a total of $7,550 of contributions: $2,000 from their employer (not subject to Federal Income Tax), and $5,550 that they contribute pre-tax, can grow tax-free, and can be distributed tax-free if used for qualified medical expenses. In a matter of one year under the HSA, John and Jane will be able to save more than enough to their HSA to cover the maximum out of pocket expenses if they were to have a medical emergency. In addition to the tax savings and employer contributions, their goal is to pay out of pocket for their medical expenses (not from the HSA) in order to build up their tax free reserve for retirement. Not only are they paying less in premiums and saving more in taxes by utilizing the HSA, John and Jane are empowered to take control of their health and be more engaged in health care decisions going forward.
Like a set of fingerprints, no two scenarios are the same, so your decision to move to an HSA is entirely dependent on your health situation, your ability to save, and your “pain tolerance” for out of pocket medical expenses.
Using an HSA for additional tax-deferred retirement savings
In a world of financial uncertainty, there are a few factors we know with certainty and for which we must proactively plan.
- The retirement outlook for current workers is changing.
- People are living longer – life expectancies are increasing and individuals must plan on the probability of living much longer, possibly 30+ years in retirement.
- Retirement health care costs continue to rise – as you can see from the chart to the right.
Many workers have already maxed out their tax-deferred savings at work (e.g. 401(k)), and/or their income is too high to contribute to a Roth IRA or tax-deductible IRA. The responsibility for a successful retirement now rests squarely on the worker’s shoulders, but individuals face challenges presented by contribution limits, income phase-outs and taxation issues, and are always looking for opportunities to maximize current tax-deferral while still saving for the future.
A bit of good news – did you know that your HSA can double as a supplemental retirement savings vehicle? Regardless of the fact that HSAs have fairly low contribution limits (refer back to table 1), your HSA can be used as an extra source of targeted retirement savings, and as mentioned previously, HSAs provide a triple tax advantage when used for qualified medical expenses.
- Contributions to an HSA are tax-deductible on your Federal Income Tax Return (or contributed pre-tax if associated with an employer plan)
- Earnings on invested assets within an HSA are tax-deferred
- HSA distributions are tax-free when used for qualified medical expenses
You know you will have out of pocket health costs in retirement. You also know that health care costs are increasing at an alarming rate. If an HDHP makes sense for your current health situation, it certainly makes sense to maximize your HSA contributions if you are able, to ensure you are taking full advantage of the tax advantage of an HSA. It is the only savings vehicle available that has this type of tax-advantage, and is portable year after year, even if you leave your employer. The illustration to the right illustrates how the basic tax advantages of an HSA stack up against other retirement savings vehicles.
Take control of your health care
Not only do HSAs come with major tax saving benefits, but studies have also shown that enrollees in consumer dependent health plans (CDHP) such as an HDHP/HSA combination are more in control of their chronic health issues and are more engaged in their care. These enrollees were 21% more likely to participate in disease management programs than those with traditional coverage, and they also found a slower growth of health costs among CDHP enrollees.  Those who are more engaged in their health care are more likely to shop for affordable care, and are also more likely to ask good questions about the necessity of testing, ongoing treatment, more affordable pharmaceutical options, etc. When a higher proportion of the financial responsibility rests on the consumer’s shoulders, individuals and families are motivated to stay engaged and knowledgeable about their health care, another benefit of HSAs.
HSAs come with many advantages, but as with other financial issues, there is no “one-size-fits-all” solution. Do the math to see if a typical year of medical costs for you are better served by an HDHP/HSA, but don’t discount the mental shift that will need to occur when switching from a traditional copay arrangement to a more self-directed plan. Speak with a trusted financial professional and/or tax professional to see if you should consider switching to an HDHP/HSA during your next benefits enrollment period. If you have recently made the switch to an HSA and have questions about your new benefits, consult with your financial advisor.