Invest in your health

The Patient Protection and Affordable Care Act (PPACA) has altered much of the traditional health insurance landscape. One health insurance plan that has remained virtually unchanged is the High Deductible Health Plan (HDHP), which can be combined with a Health Savings Account (HSA.)

The only modifications that PPACA made to HSAs were to:

1. Restrict the use of tax-free dollars to purchase over-the-counter drugs not prescribed by a doctor and,
2. Increase the tax on HSA distributions that are not used for qualified medical expenses from 10 percent to 20 percent.

It is important to understand that an HSA receives better tax treatment than any other savings approach. Annual contributions to an HSA are fully deductible in the tax year in which the contribution is made, just like an IRA. What makes an HSA unique is that all of the funds contributed plus all of the growth and income from an HSA can be withdrawn tax free to pay for qualified health care expenses, just like a Roth IRA. An HSA is the only investment vehicle which receives both immediate tax deductibility and tax free withdrawals, as long as the funds as are used to pay for qualified health care expenses.

When HSAs are fully funded each year, the combination of lower cost health insurance through an HDHP with the generous tax treatment of an HSA, should make this approach to health insurance a virtual “no-brainer” for many people. If your family’s taxable income is above $68,000 (the beginning of the 25 percent marginal federal income tax bracket) and you contribute the family maximum of $6,150 to an HSA, the after tax cost of an HDHP will be always be less than a the cost of a traditional health insurance plan.

If a traditional health insurance family plan costs $400 per month, the High Deductible Health Plan will cost approximately 20 percent less or $320 per month. The HDHP appears to save only $80 per month or $960 per year. If the traditional health plan has an annual deductible of $1,000 and the HDHP has a $3,000 deductible, the $960 yearly savings may not be worth the risk of possibly paying $2,000 more in deductible expenses. This is true, until we consider the after tax cost of an HDHP/HSA combination.

Since tax free HSA funds can be used to pay the medical expenses required for the HDHP’s deductible, the “before tax” deductible cost is the same as the “after tax” deductible cost of $3,000. With the traditional plan, medical expenses are paid with after tax dollars. Thus, if a person is in the 25 percent federal income tax bracket, a $1,000 deductible actually requires $1,333 in pretax dollars. On a pretax basis, the difference in deductibles is $1,667, not $2,000. Thus, the traditional plan, costing $960 more would provide a maximum “savings” of ($1,667 – $960) = $707.

When an HSA is fully funded, the savings by using an HDHP become significant. For a family with taxable income over $68,000, a $6,150 HSA deposit will provide an immediate federal income tax savings of at least ($6,150 *25 percent) = $1,537.50. By including the HSA contributions income tax savings, the HDHP plan costs $830.50 less ($1,537.50- $707) than the traditional plan. And this is in a “worst case” scenario, where the annual health care costs exceed the $3,000 deductible. If annual medical expenses are only $1,000, the HDHP/HSA combination would cost $2,830.50 less than a traditional plan.

If you are in a higher federal tax bracket or if you pay state income taxes, the HDHP/HSA savings are even greater. Plus, HSA funds that are not required for immediate health care expenses can continue to grow in the HSA, on a totally tax free basis, until they are eventually withdrawn for qualified medical expenses.
If your family taxable income exceeds $68,000 and you have an HDHP available, choose the HDHP and fully fund the HSA. Your financial advisor can provide a personal financial analysis to demonstrate what you will save with an HDHP/HSA combination health plan.
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