With all of the recent turmoil in the health insurance market, one clear success story has been the survival of High Deductible Health Plans (“HDHPs”). Like most forms of liability insurance and term life insurance, HDHPs offer protection against large and potentially devastating events. And, the premiums are generally lower than with traditional PPO or POS arrangements. The trade-off vs. other types of health plans is that insured persons with HDHPs are required to meet higher deductibles before the insurance policy begins to pay expenses. One market-wide benefit: the higher deductibles of HDHPs cause policy holders to become more cost conscious as they weigh potential health care choices.
Health Savings Accounts (“HSAs”) are tax-advantaged vehicles that can accompany HDHPs, and are generally administered by financial institutions. Like 401(k) deferrals, employee contributions to HSAs are made pre-tax, and as long as eventual withdrawals are for Qualified Medical Expenses (“QMEs”), those contributions may actually be tax-free. Naturally, withdrawals for non-qualified expenses are strongly discouraged by the IRS, resulting in income tax liabilities and, potentially, 20% penalties. However, at age 65, HSA owners are able to withdraw money from HSAs penalty-free – similar a traditional IRA withdrawals in retirement.
QMEs include obvious out of pocket costs for office visit co-pays, hospitalizations, and prescriptions, but premiums for long-term care insurance also qualify. IRS Publication 502 describes the limits of QMEs in detail.
Another benefit of HSAs accrues when owners don’t use their accumulated annual contributions for current QMEs. HSA surplus balances maybe invested, providing an IRA-like supplemental savings vehicle. As an example, imagine John Doe and his family are covered by an HDHP through his employer. The maximum allowable family contribution in 2015 is $6,650, (or $7,650 if John were 55 years or older). Suppose that after contributing the maximum to his HSA in 2015, John and his family enjoy a very healthy year and spend only $1,650 for QMEs. In 2016, John contributes the maximum again. The balance of John’s 2015 contribution in his HSA, $5,000, can be invested and grow tax-deferred until he withdraws the money after age 65.
HSAs and HDHPs offer many advantages over traditional health plans, including their functioning like tax-deferred investment vehicles. If you have further questions about HSAs, you can find many answers in IRS Publication 969. Another helpful site is hsacenter.com, which is administered by Golden Rule Insurance. For specific advice, we encourage you to consult your tax advisor.