It's open enrollment season for health-care insurance at many employers.
Increasingly on the menu? High-deductible health-care plans, which are often accompanied by health savings accounts. According to a late-2012 report from Mercer Consulting, 22% of employers now offer a high-deductible plan, and 16% of workers are enrolled in such a plan. The larger the employer, the more likely an HDHP/HSA combination will be on the menu. In some cases, high-deductible plans are employees' sole health-care options; at other employers, workers can choose between a traditional health-care plan with a higher premium and/or one with a higher deductible.
For workers who don't have cash on hand to defray health-care expenses, being forced into a high-deductible plan can be a major bummer. Not only could unanticipated health-care expenditures--and correspondingly high out-of-pocket costs--derail their budgets or force them to take on debt, but being on the hook for high out-of-pocket costs could also prompt them to delay attending to their health-care needs altogether.
But for higher-income workers, a high-deductible health-care plan can be a terrific option. For people with few health-care expenses, the plans can be a win from the get-go because they typically feature lower premiums to compensate for the insured party's high out-of-pocket costs. (Of course the opposite can also be true: If one encounters a costly medical condition--and it's a rare health condition that is costly to diagnose and/or treat--the cost savings of lower premiums can quickly be swallowed up by high out-of-pocket costs.)
However, the real benefit of a high-deductible plan for higher-income workers isn't so much the year-to-year premium savings--which may or may not be offset by higher out-of-pocket costs. Instead, the key benefit is that participating in a high-deductible plan enables you to invest in a health savings account. Such accounts offer the only triple tax advantage in the whole tax code: You contribute pretax monies to the account, enjoy tax-deferred compounding, and take tax-free withdrawals for qualified health-care expenses. This three-fer, and the fact that there simply aren't that many tax-advantaged savings vehicles available, is one reason that Morningstar.com readers were so enthusiastic about their HSAs when I queried them on this topic last year (http://news.morningstar.com/articlenet/article.aspx?id=570385). (In the interest full disclosure, I'll say that I've been a happy HDHP participant/HSA owner for the past year, and recently re-upped for this option as part of Morningstar's health-care plan.)
Roger Wohlner a financial planner with Asset Strategy Consultants in Arlington Heights, Ill., believes that the HDHP/HSA combination can be beneficial on several levels. "The difference in premiums alone generally make a high-deductible plan with an HSA a good deal. The HSA option also provides a 'piggy bank' if needed to meet the deductible and can serve as a great tax-deferred savings vehicle."
Sue Stevens, CEO of Stevens Wealth Management in Deerfield, Ill., also likes HSAs as tax-deferred savings vehicles and encourages clients to take advantage of them. She notes, however, that "more clients could be taking advantage of them, but they don't really understand how they work."
Here are some common objections to HSAs as well as a discussion of whether those objections are valid.
Objection 1: Aren't HSAs "use it or lose it"?
No. People often confuse HSAs with flexible spending accounts, which until recently were "use it or lose it"--meaning that the money couldn't be rolled over from one year to the next--unless plans allowed employees a grace period. Unused monies in HSAs, by contrast, always automatically roll over from year to year.
HSAs are also portable, meaning that you can keep your HSA even if you've left your employer or if you're no longer covered by an HSA-eligible plan. (You won't be able to make additional contributions to the HSA if you're not in an HDHP, however.)
Objection 2: Why would I want to tie up a lot of my money in a vehicle if I can only withdraw the proceeds for health-care expenses?
You're right that monies in your HSA can only be withdrawn tax-free to cover health-care expenses for you, your spouse, or your dependent children. But the list of covered expenses is long, encompassing everything from physician's fees, drug costs, and surgeries to eyeglasses and exams, fertility treatments, and weight-loss programs. (The list of qualified HSA expenses--found in IRS Publication 502--is the same one used to determine the deductibility of medical expenses.) Withdrawals from HSAs can also be used to pay long-term care premiums or long-term care expenditures. Considering that the typical 65-year-old couple will spend $220,000 in health-care costs in retirement, according to an estimate from Fidelity Benefits Consulting, it's unlikely that many people will get to retirement and wish they hadn't earmarked so much money for health-care costs.
It's also important to note that withdrawals in retirement don't need to be used for health-care expenses at all. Although withdrawals for qualified medical expenses during retirement will be tax-free, just as they were when you were working, you can withdraw the money for any reason after age 65. You'll owe taxes on those distributions, but no penalty. In that respect, saving in and making in-retirement withdrawals from an HSA is just like saving in and investing in a traditional 401(k) or traditional deductible IRA: You make pretax contributions and enjoy tax-deferred compounding, but you owe tax upon distribution. (Cracking into an HSA prior to age 65 for non-health-care-related expenses is more onerous than cracking into an IRA or 401(k), though; you'll pay tax on the distribution as well as a 20% penalty.)
Objection 3: Why would I want to tie up money in a savings account when I could invest it instead?
Despite the word "savings" in the term "health savings account," monies invested in an HSA needn't necessarily be hunkered down in a cash account and earning next to nothing. Increasingly, HSAs allow participants to purchase long-term investments within the HSA wrapper. Health Administrators, for example, offers 22 Vanguard funds. HSA Bank allows savers to invest in a wide range of securities (stocks, funds, and exchange-traded funds) via a TD Ameritrade (AMTD) brokerage account.
However, if you intend to pay your out-of-pocket health-care costs out of your HSA, make sure you're steering enough money into liquid assets. That way you won't need to pull assets out of your long-term holdings when they're at an ebb.
Objection 4: I took a look at the details on the HSA that I can contribute to, and was dismayed by the transaction costs.
Alas, high costs remain the sticking point with many HSAs, and can chip away at the wrapper's many tax benefits. There are frequently fees to set up the HSA, ongoing annual or monthly maintenance fees, transaction fees, and fees for using debit and checking features. Because many of these fees are levied on a dollar basis, rather than a percentage basis, you can downplay the toll they take by adding more assets to your account. This article (http://news.morningstar.com/articlenet/article.aspx?id=570460) discusses conducting due diligence on an HSA as well as what you should know before venturing beyond the HSA that your employer has selected as the default option.