The deadline for 2017 benefits enrollment is approaching quickly for many employees.  More and more employers have started to offer high-deductible health insurance plans in addition to the traditional HMO or PPO plans.  You can set up health savings accounts (HSAs) only if you choose one of the high-deductible health insurance plans instead of the traditional HMO or PPO health insurance plans with co-pays.  What do you need to know about HSAs in order to make a wise decision for yourself and your family?

High-deductible health plans can cost less than other health plans.  In addition, tax benefits from using HSAs can further reduce your net costs. 

HSAs have triple tax benefits:
 

1. Contributions are tax deductible.  For year 2017, Self-only plan has contribution limit of $3,400 ($50 increase from year 2016).  Family plan has contribution limit of $6,750 (no change from year 2016).  Individuals aged 55+ may contribute an additional $1,000 for each tax year.  If your employer offers a “Self plus one” option for health insurance, that means the family plan. The IRS limit is for the total of the employer’s and employee’s contributions.  For example, if your employer contributes $1,500 for a family plan, then you can only contribute up to $5,250 to your HSA this year.
2. Investment earnings are tax-deferred.  Some HSA administrators offer investment options such as various mutual funds.  If you do not plan to use much to pay for out-of-pocket expenses in the upcoming year, then you can choose to invest the money for a longer time horizon as there is no expiration date for using the funds.  You do not need to report earnings on your tax returns.
3. Funds you withdraw from your HSA are tax-free when used to pay for qualified medical expenses.  The expenses must be primarily alleviate or prevent a physical or mental defect or illness, including dental and vision.  A list of these expenses is available on the IRS website, www.irs.gov in IRS Publication 502. Any funds you withdraw for non-qualified medical expenses will be taxed at your income tax rate plus 20% tax penalty if you are under 65.

What type of health plan will give me a better financial value?

It depends.  You should consider all of the cost elements associated with each plan option: monthly premiums, your deductible, maximum out-of-pocket as well as co-pays and/or co-insurance.  So depending on your health needs, a high-deductible plan may cost less overall than repeatedly paying a traditional plan’s co-pays and co-insurance.  

Generally if you are relatively healthy and do not expect to incur more than $5,000 in medical expenses annually, with the tax savings upfront and the option to invest the money for future tax free withdrawals, you are better off choosing the high-deductible plan with a fully funded HSA account.  The higher your income is, the more your tax savings will be from the contributions to your HSA. 

For example, your total tax savings for year 2017 would be $2,700 if you contribute $6,750 to your HSA when you have a family plan, assuming your combined federal and state marginal tax rate is 40%.  If your annual premium saving is $4,000 (depending on the deductibles) compared to a traditional plan, then you would have total of $6,700 that you could use to fund your HSA.  You can choose payroll deductions if your employer offers it or you can fund it any time by writing a check to your HSA administrator if you are self-employed.

In addition to making pre-tax contributions to your HSA, if your employer offers health flexible spending account (FSA), you can also choose to contribute pre-tax dollars to your FSA to pay for vision and dental expenses for year 2017.  Keep in mind that you should not overfund your FSA as the money does not carry forward to future years.  You should use your funds inside your FSA first, before using the funds inside your HSA to have more money growing tax free. 

Unlike the FSA, the funds inside HSAs are not “use it or lose it”.  Most people do not need to worry about overfunding the HSAs because the funds can be used to pay for premiums for a portion of qualified long-term care insurance, or health insurance between jobs, or Medicare premiums.  

If you die with a balance inside your HSA, your spouse can inherit it as his/her HSA if you name your spouse as the beneficiary for the account.  If there is no surviving spouse or your spouse is not the beneficiary, then the account will cease to be an HSA and will be included in the federal gross income of your estate or your named beneficiary. 

In my opinion, having a high-deductible plan combined with a HSA offers incentives for people to stay healthy by eating right and exercising frequently in order to potentially reduce medical expenses over time.  However, I can think of some drawbacks of having a high-deductible plan such as not seeing doctors for minor illnesses to avoid current costs which could potentially make the illnesses worse, triggering even larger medical bills in the future.  I suggest that you set up adequate liquidity ($1,000 to $2,000) inside your HSA that is not subject to stock market volatility to pay for the small bills next year if you do not have funds outside of the HSA to pay.  Low income people may not be able to set aside enough money inside HSA and the tax savings are minimal.

Rules When Spouses Are Both HSA Eligible:

If you and your spouse both are interested in selecting a high-deductible health plan in your respective workplaces and making contributions to a HSA, you need to be aware of the total family contribution IRS limitation.  If one of you has self-only coverage and the other one has family coverage.  The self-only contribution limit ($3,350) plus the family contributions limit ($6,750) will be $10,100 that exceeds the family limit of $6,750.  Therefore, you can choose to split the total $6,750 family limit equally or in other ways.  Keep in mind if your employer contributes to your HSA, then the total of your and your spouse’s contributions and employer’s contributions cannot exceed the $6,750. 

As there are benefits of opening two HSAs to ensure each of you can contribute additional $1,000 when you reach the age of 55, it may be better to each open you own HSA, figure out your collective contribution limit, and decide how you will split that limit between the two accounts to avoid over-contributing.

Wealth and health planning are integrated nowadays as we plan to live longer and healthier lives.  Making the right decisions on choosing health plans and taking actions to stay healthy are important to your wealth now and for many years from now. Tax laws and health plans keep changing - talk to your trusted financial advisor soon to make informed decisions based on your own circumstances and goals.