Health care is a very hot topic in 2017. The new administration made it their leading agenda item, though we have yet to see a plan agreeable to both sides of the aisle. As Republicans contemplate how to replace the Affordable Care Act (ACA) with a good alternative, Health Savings Accounts or HSAs are expected to figure prominently. President Trump has made the expansion of access to HSAs an important measure for his health-care plan and conservative proposals are using expanded eligibility and increased contribution limits as key elements in their plans. We think it is a good time, therefore, to understand how these plans might fit into an overall health care and investment strategy.
Health care costs are rising and the costs and inflation associated with health care are a tremendous consideration for retirement planning. There are varying estimates of costs for retirement health care –some estimates show that a 65 year old couple will need an average of $260,000 for 20 years of healthcare spending. At DWM, we actually look at health care as a separate spending goal in our financial plans because of the higher inflation and importance of adequately preparing for these costs.
Here is where an HSA may come in. HSAs offer an opportunity to take advantage of triple tax benefits to pay for some of this cost. HSA contributions can be deducted or paid pre-tax, there is tax-free compounding while in the account and no tax is paid on qualified withdrawals for health care. It’s a trifecta of tax advantage! After age 65, you can make withdrawals for any reason and pay regular income tax just like you would for an IRA, but there are no required minimum distributions. However, using the funds for non-qualified expenses before you are 65 results in a stiff 20% penalty plus the normal taxes.
Let’s look at how HSAs currently operate. You are eligible to contribute to a Health Savings Account if you are part of a high-deductible health plan (HDHP) and as long as you have not signed up for Medicare. There is an annual contribution maximum and, for 2017, it is $3,400 for an individual and $6,750 for families. A HDHP, in 2017, means your deductibles must be at least $1,300 for an individual and $2,600 for a family with maximum out-of-pocket expense requirements of $6,550 for an individual or $13,100 for a family policy. The lower premiums charged for this kind of coverage have attracted consumers and employers alike. Given the ACA’s requirements that certain preventive screenings, annual visits or prescription drugs be covered regardless of deductibles, these policies are now more attractive and palatable to average health care consumers. These plans are also becoming more popular as employers look for ways to manage their employee benefit costs.
You can make withdrawals from the Health Savings Account for many traditional healthcare expenses and the qualified expenses can also include things that you normally pay for with after-tax dollars, like vision or dental care and supplies. It might be a good way to pay for braces for your child or eye exams that might not be otherwise covered. This might be one way to use HSAs – as a tax-free payment for the costs of the deductibles on the HDHP, as well as some additional medical expenses. The other beneficial use is as an extra savings vehicle to be used in retirement for those future retirement health costs, including some of the long-term care costs that Medicare doesn’t pay. Also, the pre-tax contributions that you are allowed to make to these accounts can be in addition to your contribution maximums for other qualified accounts. You can also, like IRAs at age 50, make $1,000 “catch-up” contributions to your HSA at age 55.
There are some downsides to these accounts. High deductible plans might not be the right choice for everyone; each individual or family will have to evaluate their situation carefully. Also, the HSAs are not offered by every financial institution and the investment choices and administrative costs should be investigated before committing to one. It also takes disciplined saving to make the most of the tax advantages.
We do think there could be a place for these accounts in certain circumstances and, as the political negotiations continue to unfold, it is good to understand their pros and cons. We recognize the importance that health care costs play in preparing for financial independence. As your holistic financial advocate, we would be glad to help you evaluate how a health savings account might fit into your overall plan to help you reach your goals.