It's open enrollment season for employer-provided health insurance and other benefits. Increasingly on the menu at many companies? High-deductible healthcare plans, usually paired with a health savings account.
Among large employers, 70% offered a high-deductible healthcare plan on their benefits menus in 2018, an increase of 12 percentage points since 2016, according to Society for Human Resource Management. The vast majority of firms offering high-deductible healthcare plans also offered a traditional health insurance plan such as a preferred provider organization, though 5% of employers were offering a high-deductible healthcare plan as the sole healthcare option.
The uptake of high-deductible healthcare plans no doubt strikes fear into the hearts of employees who don't have the funds on hand to pay out-of-pocket healthcare costs as they incur them. In order to qualify as high deductible, a plan must have a deductible of at least $1,350 for single insured individuals and $2,700 for family coverage. The IRS also sets upper limits on the insured person's out-of-pocket outlays (deductibles, copays, and coinsurance) but the numbers are eye-wateringly large: $6,650 for individuals and $13,300 for families in 2018. Those numbers will drift even higher next year, to $6,750 and $13,500, respectively
But a high-deductible healthcare plan isn't always a financial killer; depending on situation, it may even be a good deal. That’s because high-deductible healthcare plan premiums are typically substantially lower than is the case with PPOs, for example, and some routine healthcare services are covered, at least in part, regardless of whether the deductible has been met. In addition, many employers cap employees' maximum out-of-pocket outlays well below the upper bands set by the IRS.
Most important, high-deductible healthcare plans are usually offered side-by-side with a health savings account, which employees can use to amass tax-sheltered cash for those healthcare outlays. As an incentive to contribute to the account, they're triple-tax-advantaged: Pretax contributions go in, interest and investment earnings build up tax-free, and withdrawals for qualified healthcare expenses are also tax-free. Some employers also contribute to the HSA for their employees. In 2019, the maximum allowable contribution to an HSA is $3,500 for people with self-only coverage and $7,000 for families.
2 Main Ways to Use an HSA
There are two key ways to use an HSA. The first is just what you'd expect: The HSA is used to cover out-of-pocket healthcare expenses as they're incurred. Because the assets don't remain in the account long enough to benefit significantly from the tax-free earnings, the main benefit is the ability to make pretax contributions to the account. That ability to make pretax contributions mean that employees covered by a high-deductible healthcare plan should measure the premium differential between the PPO (assuming one's on offer) and the high-deductible healthcare plan, then fund the HSA to at least that level.
The second use case for an HSA is as a long-term savings vehicle, and that's when the tax benefits really mount. If the insured can leave the HSA asset undisturbed and pay healthcare costs with non-HSA assets, that better harnesses the tax-sheltered compounding. Such a strategy is often characterized as best suited for the "healthy and wealthy"--after all, not having many healthcare expenses reduces the need to use your own funds for the HSA, but you'd need to have non-HSA cash on hand in case they do. As discussed here, an investor using an HSA as a long-term savings vehicle would be way ahead of the investor who saved within a taxable account, and might be even ahead of the investor saved within a 401(k)! I've even seen articles making the case that saving within an HSA is better than saving in a 401(k), but the broad variations in HSA quality make me stop short of making a blanket statement like that.
And Three 'Secret' HSA Uses
Yet even as you've probably heard about using an HSA as a short-term vehicle to cover ongoing healthcare outlays, and as a long-term savings vehicle to harness the tax-sheltered compounding, the ability to use an HSA for other financial objectives has gotten less attention. Here are three additional ways that an investor can use an HSA.
To Cover Non-Healthcare Expenses Prior to Retirement
Sure, you may have had the best of intentions to delay withdrawals from your HSA for many years, so you've covered healthcare expenses using non-HSA (taxable) assets. The good news about this strategy is that it offers an escape hatch. If, later on, you determine that you need additional funds for something, even non-healthcare related items like a new roof or a car repair, you can withdraw that amount from your HSA without triggering taxes. The big caveat is that your previous healthcare expenses, which you've never covered with your HSA before, would need to at least equal the amount of the withdrawal. It's also crucial that you'd have saved receipts to document the previous health'care expenses. One neat element of this strategy is that the healthcare expenses don't even have to have occurred in the same year in which you take the withdrawal for non-healthcare-related expenses.
To Cover Any Expense After 65
Once you're past age 65, withdrawals for non-healthcare expenses are even more straightforward. You can withdraw from your HSA for any reason at that life stage.
If the withdrawals are for non-healthcare expenses, they'll be taxed exactly as an IRA or 401(k) withdrawal would be. In other words, you'll pay taxes on your withdrawal, but you've been able to take advantage of a free ride on taxes (pretax contributions, tax-free compounding) up until that point. That flexibility makes the HSA a perfectly viable ancillary retirement savings vehicle.
It's also worth noting that people who are 65-plus can knit this and the aforementioned strategy together. Even if you used non-HSA assets to cover your healthcare expenses and leave your HSA money undisturbed until age 65, you could pull the money out tax-free, provided you've saved your receipts for the healthcare expenses you covered out of pocket in the years before that.
To Cover Long-Term Care
Health savings accounts can also be used to cover long-term care, in one of two key ways. The first is to purchase long-term care insurance: People between 41 and 50 can withdraw $780 of their HSA assets to cover long-term care premiums in 2018; people between 51 and 60 can steer double that amount ($1,560) to cover long-term care premiums; those between 61 and 70 can withdraw $4,160; and those 71 and older can withdraw $5,200. (Long-term care premiums typically scale up with age, so it makes sense that the allowable withdrawals would increase, too.) Those limits typically increase a bit each year.
Alternatively--for people who decide to self-fund long-term care costs rather than purchasing insurance--HSA assets can be withdrawn to cover long-term care expenses as they-re incurred. In contrast with using HSA assets to pay premiums, this strategy best harnesses the tax-free growth potential that comes along with the HSAs. Qualified HSA withdrawals--and most long-term care costs would qualify--would be tax-free; withdrawals post-age 65 for other expenses would be subject to ordinary income tax but no penalty, as outlined above.