The Health-Care IRA. Are you Ready?
Health savings accounts are on their way. Here's what to do when they arrive
(MONEY Magazine) – Fall is coming and so is open enrollment season, the time when you can review and choose your benefits. That means navigating an alphabet soup of plans and accounts. Should you spring for an FSA? Enroll in an HMO? Opt for a PPO? (It almost takes a Ph.D. to know.)
This year an important new acronym joins the mix—the HSA, or health savings account. These new health plans combine a low-cost, high-deductible insurance policy with a tax-free savings account. Think of them as super-charged IRAs for health-care expenses.
HSAs came on the market in January as part of last year's Medicare overhaul, but companies are only now rolling them out to employees. While few firms are expected to offer HSAs this year, a recent survey of 991 companies of all sizes by benefits consultancy Mercer found that 43% are likely to offer them next year and 73% are likely to do so in 2006. Some firms, says Mercer's Ray Herschman, plan to make HSAs their only option.
How an HSA works
The idea behind HSAs is simple: If consumers had to pay more of their healthcare expenses out of their own pockets, they would make better (read cheaper) choices. The hope is that HSAs will put a lid on spiraling health-care costs while still protecting users against catastrophic medical problems.
To qualify, you must be under the age of 65 (and thus not eligible for Medicare) and have a high-deductible health insurance policy. That means a minimum deductible of $1,000 for singles, $2,000 for families. You may be offered such a policy through your job or you can buy one yourself. Generally speaking, the higher your deductible, the lower your premiums. You (or your employer) can then fund the HSA, with pretax dollars, up to the amount of your deductible; the maximum you can put in each year is $2,600 for singles and $5,150 for families. And as with an IRA, the money in the account can be invested through your HSA administrator.
Unlike the funds you put in a flexible spending account, an annual use-it-or-lose-it deal, the money that goes into an HSA compounds tax-free over time and is yours to keep even if you leave your job. The less you spend, the more you get to keep. You'll pay no tax when you withdraw the money as long as you use it for health care. After you turn 65, you can do what you want with it. If you cash out to pay for something other than medical expenses before age 65, you'll pay tax on the withdrawal at income tax rates plus a 10% penalty.
The first advantage is that you or your employer will pay lower insurance premiums. According to the Kaiser Family Foundation, premiums for an employer-sponsored family plan averaged $9,068 in 2003, with workers kicking in $2,412. The premiums on a high-deductible plan will run you 20% to 40% less, estimates Herschman. Whether that's a better deal for you depends on how much you actually spend on medical care each year. If you expect to have a lot of medical expenses, it may make more sense to stick with a regular insurance plan.
The other benefit comes from the HSA itself. If you don't need all the money for this year's medical expenses, it is a powerful planning tool for retirement and future medical expenses. "It's the triple-whammy of tax planning: tax-free contributions, tax-free earnings and tax-free distributions. There are very few opportunities like that," says Hewitt Associates tax attorney Andy Anderson.
To sign up or not?
If you're self-employed or your employer does not offer health benefits, an HSA may be a no-brainer since it offers affordable access to catastrophic medical coverage with a tax-planning sweetener. As long as you buy high-deductible insurance (and big insurers like Aetna, Blue Cross/Blue Shield and UnitedHealthcare all offer it), you can set up an HSA on your own. The HSA Insider website (hsainsider.com) lists qualified HSA administrators. Pay attention to fees and the investment choices offered.
If you get employer-sponsored health benefits, deciding whether to go with an HSA is more complicated. In general, if you don't spend much on health care—or can afford to pay for what you do out of pocket—HSAs can be a great way to save tax-free for future health costs or retirement. That's especially true if you've maxed out your 401(k) and IRAs.
The key is to determine your out-of-pocket costs under both an HSA and your current plan (including premiums, deductibles, co-pays and uncovered medical expenses) and compare (see the worksheet and examples below). Don't forget to find out whether your employer will put money in your HSA for you and, if so, how much.
The final issue goes beyond finances. As always when you're evaluating health insurance, you'll want to be certain the doctors you use are part of the plan and the services you need are covered. There are wide variations among providers and plans, and it's important—as always—to be sure you've got the one that covers what you'll need.
HSA OR REGULAR INSURANCE? It depends on how big your medical bills are. In SCENARIO 1, a family with annual expenses of $2,200 winds up with $2,150 left in their HSA. In SCENARIO 2, the same family has expenses of $9,000 and spends all the money in the account.
NOTES: N.A.: Not applicable. Scenarios based on family of four in 28% tax bracket, no employer contribution to HSA and insurance policy with $5,150 deductible.
SOURCE: MONEY research.