The future of healthcare is a red-hot topic right now. President Trump and Republicans in Congress have plans to repeal and replace the Affordable Care Act, also known as Obamacare, which took effect in 2010.
While we don’t know yet what a replacement or repair plan will be, there are some proposals with interesting similarities. They include an expanded use of health savings accounts or HSAs.
In this post, I’ll explain what an HSA is and why they’re one of my favorite tools to save money. I’ll also answer several listener questions about these tax-advantaged accounts and describe the role HSAs may play in healthcare reform.
See also: 6 Ways a Trump Presidency Could Affect Your Personal Finances
What Is a Health Savings Account (HSA)?
An HSA is a special tax-exempt account you can fund for the sole purpose of paying a variety of current and future qualified medical expenses, like doctor visits, dental cleanings, or eye exams and prescription glasses.
No matter if you get your health insurance through work or on your own, you manage an HSA as an individual. It’s portable and stays with you if you become unemployed, change jobs, or switch insurance companies.
An HSA operates like a checking account, with features like online access, automatic transfers, paper checks, and a debit card to manage and spend your money. If you forget to use your HSA for a qualified expense, you can also reimburse yourself from the account.
Some employers allow pretax contributions directly from your paycheck, and may even put in additional matching funds on your behalf. For instance, you might get $50 per paycheck or a large lump sum at the beginning of each year.
HSAs generally pay low interest rates on par with what you’d get at a bank. But many also offer investment funds, with the potential to earn more on your savings. You can transfer all or a portion of your balance into investment funds you choose from a diversified menu of options.
HSAs generally pay low interest rates on par with what you’d get at a bank. But many also offer investment funds, with the potential to earn more on your savings.
The big deal with an HSA, and the reason I love them so much, is that you get triple tax benefits:
1. Tax-deductible contributions – allow you to reduce your taxable income and therefore shrink the amount of tax you pay. As I mentioned, you either make pretax HSA contributions through payroll deductions (like you do with a 401k) or you claim contributions on your tax return.
For 2017, the HSA contribution limits are $3,400 if you have insurance as an individual and $6,750 if you have a family plan with at least one other person, such as a spouse or child. If you’re at least age 55, you can make an additional HSA catch-up contribution of $1,000 each year with either type of plan. These are the total limits including what you and an employer can put into an HSA.
2. Tax-free earnings – allow you to earn interest or investment growth and skip paying tax on it. This is just like the rules for a traditional retirement account, such as a 401k or IRA, where you defer paying taxes.
3. Tax-free withdrawals – is the biggest benefit and what makes an HSA so special. Taking money out to pay for qualified medical expenses is completely tax free. This applies to your original contributions plus any growth in your account.
You don’t even get that deal with a traditional 401k or IRA because you do have to tax pay on withdrawals. (Roth 401k or IRA withdrawals are tax-free in retirement, but require you to pay tax upfront on contributions.)
These are powerful benefits because they cut your tax bill and maximize your healthcare buying power. Depending on your income tax rate, using an HSA to pay for medical expenses means you could get a 20% to 30% discount. That’s serious savings!
In addition, there’s no deadline to spend your HSA money. That’s different than another type of medical savings account that you might be offered at work, called a Flexible Spending Arrangement or FSA. With an FSA, you’re required to spend all or most of your account each year, known as the use-it-or-lose-it policy.
In contrast, your HSA funds can accumulate year after year if you don’t spend them. You can make contributions at any time, even up to April 15 for the previous tax year. But you’re never required to make contributions to an HSA.
The only downside is that if you use HSA funds to pay for anything other than qualified medical expenses, the amount will be subject to income tax, plus an additional 20% penalty.
The only downside is that if you use HSA funds to pay for anything other than qualified medical expenses, the amount will be subject to income tax, plus an additional 20% penalty.
But after you reach age 65, this steep penalty disappears, which means your HSA eventually morphs into a retirement account. If you make withdrawals for non-qualified expenses, like rent or travel, they’re subject to income tax but are penalty-free, just like with a traditional 401k or IRA. So, use an HSA as an additional tool to boost your retirement savings.
See also: 10 IRA Facts Everyone Should Know
What Is a High Deductible Health Plan (HDHP)?
With all these great benefits, you might wonder why HSAs aren’t more popular. Well, the catch is that to qualify for one, you must have a special type of insurance called a high deductible health plan or HDHP.
A deductible is an amount that you must pay for covered medical expenses before your benefits begin each year. For instance, if you have a $1,000 deductible and need a medical procedure that’s covered 100% by your policy and costs $3,000, your insurance will only pay $2,000.
But once the deductible is paid, you don’t have to pay it again for the remainder of the calendar year. So, if you had the same medical procedure for a second time before the end of the year, your insurance would pay $3,000.
While you might think that it’s better to have a lower deductible, so you pay less out-of-pocket, having a higher deductible reduces your monthly health insurance premiums. Deductibles and premiums work like a seesaw—when one goes up the other goes down.
Since health insurance has become more expensive year after year, more consumers are choosing high deductible plans to keep premiums down. Unfortunately, many aren’t pairing them with an HSA for additional savings. So, no matter if you purchase health insurance on your own or through work, find out if it qualifies for an HSA, so you can get every possible benefit.
For 2017, a health plan must have an annual deductible of at least $1,300 for an individual, or $2,600 for a family plan, to be considered a high deductible plan. However, it’s not always that simple, as I’ll explain in a moment.
See also: 7 Ways to Save on Healthcare and Fitness
Health Savings Accounts Q&A
I received several great questions from Money Girl Podcast listeners about the rules for enrolling in and using a health savings account. ‘
HSA Question #1:
Paul, I. says, “Over the past couple of years I’ve had a high-deductible plan with two different insurers, but was told that neither one was eligible for an HSA. Are there other prerequisites, beside the deductible, that I should be aware of?”
Answer:
Yes, it’s possible to have health insurance with the deductibles I just mentioned ($1,300 for an individual or $2,600 for family coverage), that doesn’t make you eligible for an HSA.
Unfortunately, if your health plan gives you certain benefits beyond allowable preventative care before meeting the deductible, it’s not HSA-qualified. For instance, if there are co-pays for doctor visits or prescription drugs, before you meet the deductible, your plan is too rich in the eyes of the IRS to qualify for an HSA.
So, when you’re shopping for coverage, if the name of a health plan doesn’t include “HSA,” be sure to inquire if it’s HSA-eligible. That could make a big difference when comparing your options through an employer or on your own.
See also: HSA Rules After Leaving a High Deductible Health Plan
HSA Question #2:
Kathy H. asked, “My son has a high-deductible health plan and is eligible for a health savings account, but despite my urging has never opened one. He had an emergency room visit at the end of 2016. Can he fund an HSA now to pay for it?”
The IRS says that expenses incurred before you establish your HSA are not qualified medical expenses.
Answer:
No, you can’t use an HSA to pay for medical expenses that predate having the account. The IRS says that expenses incurred before you establish your HSA are not qualified medical expenses.
However, don’t forget that if you itemize deductions when you file taxes, you can claim some amount of your unreimbursed medical expenses as tax deductions. These include medical and dental care for yourself, your spouse, and your dependents.
You can deduct the amount of your total medical expenses that exceed 10% of your adjusted gross income. For more information about which expenses are deductible, see Schedule A. And for more information about which types of medical expenses qualify, there’s a long list in IRS Publication 502.
See also: 3 Fitness Tax Breaks to Save You Money
HSA Question #3:
Karen C. asked, “My husband has a high-deductible health plan and an HSA through his employer. If I’m insured on his plan, can I also open my own HSA and contribute more?"
Answer:
No, the only way to open your own HSA is to have a separate high-deductible health plan in your own name. Since you’re on your husband’s insurance, you’re part of a family plan that can only be paired with one HSA.
Having a family plan allows you to contribute up to $6,750 (or an additional $1,000 if your husband is 55 or older) for 2017. You could also put that amount in the account for 2016 if make contributions before April 15, 2017.
Even though the health plan and HSA isn’t in your name, funds in the account can still be used to pay for qualified expenses for you, your husband, and your dependents.
See also: Can You Have Multiple Health Savings Accounts (HSAs)?
What’s the Future of Healthcare?
I mentioned that there are proposals from politicians to repeal or fix Obamacare that include using health savings accounts. I won’t attempt to outline the details of various healthcare proposals, which could fill a book. Instead my goal here is to highlight how popular proposals incorporate HSAs in new or expanded ways, so you’ll be familiar with potential future changes to these special accounts.
One proposal called A Better Way comes from House Speaker Paul Ryan. Ryan’s plan would increase HSA contribution limits to total as much as a high deductible health plan’s annual deductible and out-of-pocket maximum. For a family plan, it could be more than $14,000 per year, which would more than double the current allowable contribution of $6,750.
If you don’t have health coverage at work, the Better Way plan would offer a monthly tax credit to help offset your premium. The amount would be based on your age and favor older Americans. If you opt for a plan that costs less than the tax credit, the difference would go into your HSA.
If you don’t already have an HSA, the Speaker’s plan would allow medical expenses incurred up to 60 days before you establish an HSA to be reimbursed from the account.
Another plan from Kentucky Senator Rand Paul proposes removing contribution limits to HSAs so you could put an unlimited amount of money into one. He also wants everyone to be eligible to contribute by removing the requirement that you must be covered by a high deductible health plan to get an HSA in the first place.
Paul’s plan would give individuals the option of a tax credit up to $5,000 per taxpayer for contributions to an HSA. It would also expand the definition of qualified medical expenses so funds could be used to pay for more types of expenses. His plan would include reimbursement for expenses incurred before establishing an HSA, if you set it up before the annual tax filing deadline.
The last proposal I’ll mention is called the Patient Freedom Act of 2017 from Senators Bill Cassidy from Louisiana and Susan Collins from Maine. It’s a complex plan that allows for Roth HSAs with an annual contribution limit of $5,000 (or $6,000 if you’re over age 55).
The Roth part means that your contributions would be taxable, but distributions of contributions and earnings for qualified medical expenses would be tax free—just like the rules for contributions and withdrawals for a Roth IRA.
Your Roth HSA, would also be a vehicle for the federal or state government to deposit tax credits that you could spend on health insurance or other medical expenses. The credit amount would be based on where you live, your age, income, and whether you receive health insurance through an employer.
No matter if you’re happy with Obamacare as-is or want to repeal it, there’s no denying that funding an HSA and using low-fee investment funds can make you better prepared for current and future medical expenses. And if you save more than you spend on healthcare, that money never goes to waste. Your HSA nest egg just keeps rolling over from year to year so you’ll have more to spend on a comfortable retirement.
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