This is a guest post from Joel, who is a CFP® and a serial entrepreneur who loves working on various Internet based projects. Some of his most recent ventures include various consumer comparison financial websites including websites for finding life insurance, comparing car insurance companies, and researching credit card offers. He is a newcomer to Early Retirement Extreme and one of his favorite posts is on ERE is “My 4 Hour Work Week“.
With all of the upcoming changes that will be coming down the pike due to the health care reform bill there seems to be an ever increasing desire to understand a type of health insurance option that has risen in popularity in recent years: the Health Savings Account (HSA). I personally have had an HSA for the last 4 years and I couldn’t be happier with my United Healthcare HSA 100 Plan. Additionally, Jacob mentions in the FAQ section of the site that he utilizes an HSA as well. Aside from my personal satisfaction and apparently Jacob’s satisfaction as well in having chosen a Health Savings Account I think that there are a multitude of reasons why an HSA could be a great choice for just about anyone. Here are 15 things that you should know about HSA’s before making a decision for or against an HSA.
#1 An HSA is NOT a Health Insurance Plan
“What!?! An HSA is not health insurance? What are you talking about?” Let me explain. A Health Savings Account is just that: a savings account. You can set up this special type of savings account at almost any bank and you can deposit money just like you would into a plain vanilla savings account (some HSA’s also allow stocks, bonds, and other investments). Technically, an HSA is just a savings account but practically speaking many people refer to their high deductible health insurance plans (HDHP) that are required in order to set up an HSA as an “HSA health insurance plan”. However, you should most certainly understand that an HSA is in fact made up of 2 different components: the health insurance component (i.e. the HDHP) and the savings account component (i.e. the HSA).
#2 Money Contributed to an HSA Gives You an “Above the Line” Tax Deduction
It’s pretty easy to load up on itemized deductions when doing tax planning. Charitable contributions, mortgage interest paid, health care costs, and many other things can all be taken as an itemized deduction. However, all money that you contribute into an HSA (up to certain IRS annual limits) is eligible for an “above the line” deduction. An above the line deduction is a deduction that is taken on the front of your 1040 tax return before calculating your Adjusted Gross Income (AGI) and is therefore much more valuable than an itemized deduction. In addition to being an above the line deduction, all HSA contributions are free from any income phaseouts. You could be Bill Gates and still take a deduction for HSA contributions. The higher your tax bracket then the more valuable this HSA contribution deduction becomes.
#3 Money Inside of an HSA Grows Tax Free
You are no doubt familiar with the important difference between tax free growth and tax deferred growth as it is illustrated quite nicely with the popular retirement plans the Roth IRA (and example of the former) and the Traditional IRA (an example of the latter). As long as you use the money in your HSA for qualified medical expenses (or for your retirement once you reach the age of 65) then the money in your HSA will grow tax free and NOT just tax deferred.
#4 Money Inside of an HSA Rolls Over from Year to Year
Many people mistakenly assume that Health Savings Accounts are exactly the same as a Flexible Spending Account in that the money must be used up every year (“use it or lose it”). While this is certainly true of Flexible Spending Accounts the great thing about money contributed to an HSA is that the money rolls over from year to year and continues to build – and hey, if you don’t end up using all of the money in your HSA for medical expenses by the time you are age 65 then that is a good thing for two reasons: A) You didn’t have a lot of medical expenses and B) You can now use the money in your HSA that has been growing tax free for your retirement.
#5 When You Change Your Health Plan You Don’t Have to Change Your HSA
Another common assumption about HSA’s is that once you sign up for an HSA that if you ever want to find a new health insurance plan that you will then have to shut down your HSA as well. This is not true. Since an HSA is simply the savings account component of the mix then you are free at any time to change health insurance companies and purchase a new health plan while still maintaining your HSA at your current bank. Of course, your new health insurance plan must still meet the IRS requirements for a high deductible plan although you are free to switch to any company you like (and in fact shopping around and comparing health insurance plans at least once per year is a smart way to make sure that you always have the best plan for the lowest rate as rates can change often).
#6 High Deductibles are NOT Really that High
Many people are scared off by the term high deductible health insurance plan. An HSA sounds great in theory but for some it can be very hard to switch from the copay plans that they have had for all of their adult lives to a high deductible plan with no copays. The current IRS definition of a high deductible health insurance plan for 2010 (the limits change every year as they are indexed for inflation) is a deductible of no lower than $1,200 for an individual and $2,400 for a family. Sure, if you purchase an HSA and the next month you get hit with a huge medical bill then you likely may feel the pain of having to shell out $1,200 if you have an individual plan or $2,400 for a family plan to meet your deductible but if you can make it through the first year and at least max out your HSA contribution for the first year then from years 2 and on you have money just sitting in your HSA waiting for you to use it to pay towards your deductible as soon as you need it – and growing tax free at that!
#7 Your Out of Pocket Expense is Limited by Law
Another thing that scares many people with a HDHP is that they think that their potential for paying for their health care costs extends virtually forever. However, in all HSA compatible health plans must adhere to certain maximum out of pocket cost limitations imposed by the IRS. For 2010 those out of pocket limitation are $5,950 for individuals and $11,900 for families. Also, the more that consumers are forced to pay for their health care out of their own pocket (at least initially until the insurance kicks in) then the more price conscious we will all become which will in turn drive down health care costs across the board (and hey – a side benefit is that we might even start to pay attention to things like our BMI, our VO2 Max, eating healthy, etc. as we will start to realize a direct cause and effect relationship between our health and our pocket books).
#8 Many Companies Offer HSA Compatible Plans
If you want a Humana plan then they have an HSA. If you want a United Healthcare plan then they have an HSA. If you want a Blue Cross Blue Shield plan then they have an HSA. If you want an Aetna plan then they have an HSA. If you – well you get the picture.
#9 HSA Money can be Invested Just Like an IRA
Anything that is eligible for investment into an IRA can be invested into an HSA. Of course, different HSA trustees at different banks may have their own internal regulations but according to the IRS: stocks, bonds, mutual funds, and CD’s are all fair game.
#10 Your HSA Money Does Not Disappear When You Die
While many are rightfully very cynical of Uncle Sam at times it is not true that when an HSA account holder dies that Uncle Sam is standing right next to the Grim Reaper ready to snatch the money out of your HSA account. HSA accounts can have beneficiaries just like any other account and the money is paid out to your beneficiary when you die or to your estate if there is no beneficiary.
#11 You Can Roll Over Money from an IRA into an HSA
Since 2007 the IRS has allowed a special one time rollover from an IRA directly to an HSA. This special rollover is not eligible for 401k’s or other retirement plans but IRA’s are allowed this special tax treatment on a one time basis.
#12 Employers Can Contribute to an HSA for an Employee
Employers can make HSA contributions on behalf of their employees. Employers can make as much or as little of a contribution as they like (while staying within the annual IRS contribution limits). There is no vesting schedule for HSA contributions. Employees own 100% of the money in their HSA at all times regardless of whether it is an employer or employee contributed amount.
#13 Paying for Medical Expenses from an HSA is Easy
Paying for medical expenses from an HSA is as easy as swiping a credit card, debit card, or writing a check. Almost all Health Savings Accounts come with debit cards and check writing privileges.
#14 Self Employed People Should Love HSA’s
When you couple the self employed health insurance premiums paid tax deduction with the HSA contribution tax deduction then you have two great above the line tax deductions that those who are self employed should try their very best to take advantage of – especially when you consider the fact that you can take both of these deductions together and there are no income phaseouts (although you can’t use the self employed health insurance tax deduction to give your business a loss).
#15 What About YOU?
What did I miss? What other things do you like about HSA’s or feel are important things to know about HSA’s?