An Extra $100k from a Family HSA

HSA Medicine Health Savings Account

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Micro-apartments.

Ladies’ night.

There are a lot of products and services targeted at singles. As a family man, I often miss out on the love from all those marketing teams out there. OK, it doesn’t really bother me, but there’s one product often marketed to singles that shouldn’t be overlooked.

A High Deductible Health Plan (HDHP).

We’ve all been there . . . those HR meetings at work in which the merits of an HDHP are touted.

“If you’re young, single, healthy, and don’t go to the doctor very much, the High Deductible plan can save you money because of lower monthly premiums!”

OK, HR reps likely don’t say “young and single” but it’s certainly implied (or maybe that’s just my jealous, middle-aged inner self speaking). If you don’t go to the doctor much, why should you pay the higher monthly premiums and copays that come with a standard health insurance plan? For singles and the relatively healthy, it makes sense though. If you can save $2,000 in premiums and only fork over $500 in total medical costs over two annual visits to the doctor, you should take that $1,500 difference every time.

But where does this leave, say, a family of five?

The Fox family makes fairly frequent visits to the doctor. We also need a fair amount of prescription medicine. Normally one would think that a medical plan that covers a majority of the upfront costs is the best option for a family like ours. I certainly did.

Until I learned to combined the powers of a High Deductible Health Plan and the magnificent Health Savings Account (HSA) that such a plan unlocks!

High Deductible vs Standard Health Insurance Plans

A typical health insurance plan pays 100% of most services but you’re responsible for a copay (usually between $15 and $35) for each visit or prescription. Plus you pay a pretty steep monthly premium.

Let’s take a look at the Standard health plan that’s available at my work and its associated cost that the Fox family would normally pay.

(Note that the numbers I’m using in this post may be slightly rounded to keep things a little cleaner. Plus I’m using a 35% overall tax rate. In Virginia, a family could pay 25% in federal taxes, 7.65% in FICA taxes (social security and medicare), and 5.75% in state taxes for a total rate of 38.4%. High income earners could be taxed at an even higher 28% or 33% federal rate, but those high earners would have already maxed out their 6.2% social security tax (part of FICA taxes) so the money we’re discussing here wouldn’t be subject to that 6.2% tax. So the overall tax rate for those taxed at the higher federal rate would still be between 35% and 40%. So I’ve settled on 35% to keep things simple.)

The Standard plan available to the Fox family has an annual premium of $6,360 that would be paid for in pre-tax dollars. Our family averages 20 visits to our doctors each year and has a $20 copay. Plus we take at least 6 different types of medication each month and have a $15 copay. We’d have a Flexible Spending Account (FSA) to pay for the copays in pre-tax dollars as well. There is no deductible.  All of this is shown in the table below.

A High Deductible plan has lower monthly premiums but you are responsible for 100% of the cost of all medical services up to a certain amount . . . perhaps $3,000 or $5,000. But after that, nearly all services and medicine is free. No copay. Nothing.

The High Deductible plan available to the Fox family has a family deductible of $3,000. So we would pay that amount and, other than a few exceptions, nothing more. An FSA is not available with a High Deductible plan, but there is still tax savings on the annual premium. The numbers for both the Standard and High Deductible plans are shown below.

As you can see, the cost of the Standard and High Deductible plans are pretty close, with the Standard plan having a slight cost advantage in our scenario.

However, the High Deductible plan’s big-league closer is the Health Savings Account (HSA), a saving and investing option so powerful that Brandon over at the Mad Fientist blog has called an HSA the Ultimate Retirement Account for the tax benefits that he details in his article.

The Short Term Health Savings Account Impact

An HSA is only available to someone who has a High Deductible Health Plan. Basically, an HSA allows you to set aside money before it is taxed and then use it to pay for health care expenses at any time in the future. But that is only one of many benefits.

  • A family can add up to $6,750 (as of 2017) to an HSA each year (additional limits for individuals and folks over 55 differ)
  • HSA contributions are not taxed
  • HSA funds do not need to be used within a specific time frame, and certainly not in the same calendar year like an FSA
  • HSA contributions can be invested (this is the big win, as you’ll see below)
  • Earnings from HSA contributions are not taxed either if the money is used on medical expenses (OK, this is big as well)
  • An HSA is portable, so it stays with you if you switch jobs (or leave all jobs!)
  • HSA contributions and earnings can be used for anything after the age of 65, although applicable income taxes are required for non-medical expenses

As an example of the upfront tax savings, $6,750 in HSA contributions can save a family nearly $2,400 in taxes for a single year, given a combined federal, FICA, and state tax rate of 35%.

Now there are different ways to look at the benefits of $2,400 in tax savings. To make it easier to compare the Standard and High Deductible plans, I prefer to frame it in the following way.

Setting aside all the health care plan numbers listed in the table above, let’s say you want to invest $6,750. If you use the Standard plan, you must invest that $6,750 after you pay taxes on that amount. So you’d have $4,350 to invest.

If you use a High Deductible plan, the entire $6,750 can be invested before taxes are paid. So you’d have $6,750 of course.

So how does our plan comparison look if we factor in our investment options?

While the Standard plan was $599 cheaper in our scenario, the High Deductible plan provides $2,400 more in investment funds. So for a single year, the High Deductible plan has a net benefit of nearly $1,700.

The Long Term Health Savings Account Impact

While $1,700 per year is nothing to scoff at, we’d be selling the HSA short if we just focused on one year. Remember that HSA contributions and earnings are not taxed if used for medical care (and there’s even more wiggle room after age 65). Let’s compare those post-tax and pre-tax investment numbers again.

Over 30 years, a single non-HSA investment of $4,350 earning a 7% average annual return is worth a little over $33,000.  But, depending on the circumstances, your earnings of $28,650 (total value of $33,000 minus the initial investment of $4,350) might be subject to taxes. For example, if a 15% tax is applied to the earnings then the total amount available equates to about $28,700 ($28,650 * 85% + initial investment).

What does our $6,750 HSA investment look like after 30 years? Nearly $52,000 with tax-free options.

So our HSA investment is worth around $23,300 more than the non-HSA investment three decades from now.

And those tens of thousands of dollars are just for investing one year’s worth of HSA benefits over three decades. If you have an HSA for only 5 years and invest those years of HSA contributions for three decades, you’d have $225,000 in your HSA for tax exempt medical expenses when you’re older. That’s over $100,000 more than 5 years of the taxable $4,350 investment equates to. Plus that $225k can be used for non-medical expenses once your hit 65, with only your income tax at that time being a factor. The graph below illustrates the described scenario, with 5 years of initial investments and then a tax hit on the non-HSA investments at the end of 30 years.

Favor pre-tax over post-tax investments and max out an HSA for 5 years? You’ll have $100,000 more in investments to use 25 years later. Who’s in? The Fox family certainly is, and our HSA game plan is as follows:

  1. Contribute the maximum amount every year even though we may not have that much in yearly medical expenses.
  2. Invest the HSA contributions, which is currently in the Vanguard Total Stock Market Index fund.
  3. Scan medical receipts for our digital records but, instead of submitting them for reimbursement now, we’ll wait so that our investments can grow.  If we ever need money, we can seek reimbursements at that time in the future.

As advertised, a High Deductible plan can be a great deal for young and single, uh, I mean, healthy people.

But a High Deductible plan can also be a terrific benefit to families who 1) have a fair amount of medical expenses and 2) invest their HSA funds effectively.

As we are in the middle of medical insurance enrollment season, I strongly suggest you run the numbers on your High Deductible Health Plan and Health Savings Account scenario.  It could mean an extra $100,000 in your future pockets.

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