Put Money in Your Pocket, By Rethinking Medical Coverage

It’s that time of the year — open enrollment — when millions of Americans are faced with health insurance choices for the upcoming year. There are always a wide range of options. On one end are those with a low deductible and low co-payments when you need medical treatment. At the other extreme are those in which you have to meet a high deductible before the plan will cover anything.

For most of my career, I went with the best plan offered. I wanted a high level of coverage for my family. Yes, it was more expensive, but I reasoned that it was insurance against a catastrophe. But I realized what a big financial mistake I had been making.

The High Deductible Health Plan

A few years ago my employer introduced some modeling tools so we could compare the overall cost of the various plans. The deluxe plan that I had been selecting would cost me over $800 a month for family coverage. On the low end of the cost spectrum, the High Deductible Health Plan (HDHP) would only cost $364 a month. The annual difference in the two plans was $5,300 a year.

So, if I had no health care costs at all, I was guaranteed to spend $5,300 more on the deluxe plan. But that would change just as soon as I started to incur health care costs. The HDHP has a family deductible of $3,000 that must be met before it will pay for any coverage. But the deluxe plan has a $1,500 family deductible, and I still have to pay $5,300 a year more for it.

Nevertheless, I started modeling the scenarios. In every scenario I modeled, from low to medium to high health care requirements during the year, the HDHP had lower overall out-of-pocket costs. I couldn’t find a single scenario in which the deluxe plan had lower overall costs.

Even in the case of catastrophic illness that resulted in months of hospitalization, the HDHP had lower overall costs. It turned out that with both plans, after the deductible was met, the plan paid for 90% of the charges. But in every case, $5,300 higher premiums with a $1,500 deductible loses to $5,300 lower premiums and a $3,000 deductible.

In my mind I had always thought that I was better-protected with the deluxe plan. Instead, I was simply paying more money each year. The downside of the HDHP is that you have to come up with the money out of pocket for the first health care charges of the year. Thus, you could find yourself paying $3,000 out of pocket for your family early in the year. The deluxe plan is taking that money (and a lot more) out of your paycheck each month through the year.

How can it be that the high deductible plan is cheaper, even in the event of significant healthcare costs? I think the reason the HDHP costs are lower is because people with more health problems opt for the more deluxe plans. Thus, the costs to the insurance companies are higher. Younger people, and people without major health problems opt for higher deductible plans with higher out-of-pocket costs (because they don’t spend much money each year on healthcare).

The Incredible Power of the HSA

But there is another incredible benefit from enrolling in a high-deductible plan. If you are enrolled in an HDHP, you qualify for a Health Savings Account (HSA).

Many are familiar with the Flexible Spending Account (FSA), where you save pre-tax dollars and use them for health care expenses. But it’s a “use it or lose it” account. Although there are some occasional carryover exceptions, in general if you don’t spend the money in the FSA for health care expenses occurred during the year in which you contributed the money, you forfeit the money.

The HSA is different. It operates like an Individual Retirement Account (IRA), in that 1). Contributions are free from federal taxes, and in nearly every state from state income taxes; 2). The accounts can be invested in a wide variety of choices such as mutual funds; 3). The account rolls over year after year; and 4). There are no limits on its growth.

However, unlike an IRA, you can pull funds from your HSA at any time to pay for medical expenses. Thus, you have all the tax advantages of an IRA, but there are no early withdrawal penalties and no income taxes due on the money you withdraw to cover eligible health expenses. In that regard, it’s better than any retirement account that I have.

There may also be a bonus. In many cases employers, including my own engineering firm, will make an annual contribution to your HSA if you opt for the HDHP. The premiums for the HDHP are lower for employers as well, so they often pass on the savings to you. In my case, this gives me an additional $2,000 benefit over the deluxe healthcare plan. That contribution is worth nearly half of my annual HDHP premium.

The HDHP was already better for me, but this additional contribution, and just the ability to contribute to an HSA, made the choice a slam dunk.

For 2022, you can contribute $3,850 as an individual to an HSA, or $7,750 if you are covering a family. If you are 55 or over, you can make an additional $1,000 a year “catch-up” contribution.

Note that anyone can contribute to an FSA, but you must be in an HDHP to contribute to an HSA. Plus, you can’t contribute to an HSA and a traditional FSA in the same year.

But there are no limitations when it comes to when a health care expense was incurred, and when it was reimbursed. If you decide not to reimburse yourself this year from your HSA for a medical expense that you incurred, you can continue to let the money grow tax-free for many years and then take the reimbursement. Just be sure to keep good records.

Finally, there are limits for high earners for conventional or Roth IRA contributions, but there are no such limits for HSAs. As long as you are comfortable with a high-deductible health plan (and I would encourage you to do some modeling as I did), an HSA is one of the most powerful tax-advantaged savings accounts you will ever encounter.

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