For people who are self-employed or do not get health insurance through employers, it’s time to shop for health insurance again. The 2018 open enrollment period runs from November 1, 2017, to December 15, 2017. Most people know that you need to compare Bronze, Silver, Gold, Platinum, PPO, HMO, POS and EPO. Also, you need to consider the deductible, the coinsurance, and annual out-of-pocket maximum individually. I understand that it is already complicated enough. However, there is one more thing that I believe everyone should consider when you shop for health insurance. It is called Health Savings Accounts(HSAs), which is often overlooked by most people.
Let’s make two things very clear. Firstly, HSAs are not health insurance. Secondly, HSAs can also be used for people who get health insurance through your employer if eligible.
What is a Health Savings Account (HSA)?
Here is the definition from the IRS website: “A Health Savings Account (HSA) is a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur.”
Like the IRA for retirement and the 529 plan for education, the HSA is designed for funding medical expenses. In my opinion, the HSA is not only the best type of accounts for current and future medical expenses, it can also be used as a great savings vehicle for retirement. I will explain it in detail below.
What are the benefits?
The biggest benefit of an HSA is what we called the triple tax advantage.
Contributions are tax-deductible
Earnings on the money in the account are tax-free
Distributions for qualified medical expenses are tax-free
This is the only type of account I know with all these tax advantages. Contributions to a traditional IRA may be tax deductible with income limitations but distributions are fully taxable as ordinary income. Earnings and distributions become tax-free for Roth IRA owner who is over 59 ½ but contributions are after-tax money. On the other hand, an HSA enjoys before-tax contributions without income limitations, tax-deferred growth and tax-free distributions for qualified medical expenses.
One thing worth mentioning here is that your health insurance premiums are generally not considered qualified medical expenses except the premium you pay for Medicare and other health care if you are 65 or older. You could find more about the definition of qualified medical expenses here.
In addition, HSAs have some extra advantages over other types of accounts.
Unlike Flexible Spending Arrangements (FSAs) which are generally use-it-or-lose-it accounts, the balance in HSAs can be carried forward until you use it.
Unlike 529 plans where you always have to pay penalties when the distributions are not used for qualified education expenses, there is no additional tax penalty on distributions from HSAs after you reach age 65. You still need to pay ordinal income tax on the distributions not used for qualified medical expense but no additional penalties.
Unlike traditional IRAs which are subject to Required Minimum Distributions (RMDs) once you reach age 70 ½, there is no RMD for HSAs.
Unlike 401(k)s where your contributions are subject to Social Security taxes, contributions to HSA through payroll deduction generally are excluded from both federal income taxes and social security taxes.
All the benefits above make the HSA one of the best savings vehicle in the U.S.
What are the drawbacks?
For most accounts with tax advantages, you have to follow certain rules in order to enjoy the benefits or you will be penalized. For HSAs, just like I briefly mentioned above, you may have to pay your regular income tax plus additional 20% tax penalties on the distributions not used for qualified medical expenses unless you are disabled, reach age 65 or die.
Another limitation on HSAs is that the maximum contribution in 2017 is only $3,400 per year for a self-only plan and $6,750 per year for a family plan. There is an additional $1,000 contribution allowed for people who is age 55 or older at the end of your tax year in 2017.
The biggest drawback of HSAs and the reason a lot of people don’t even know about the existence of HSAs is its stringent eligibility requirement explained below.
Who is eligible?
Here are the specific requirements to qualify for an HSA from the IRS website.
“To be an eligible individual and qualify for an HSA, you must meet the following requirements.
You are covered under a high deductible health plan (HDHP), described later, on the first day of the month.
You have no other health coverage except what is permitted under other health coverage, later.
You are not enrolled in Medicare.
You can’t be claimed as a dependent on someone else's tax return.”
The key requirement here is the high deductible health plan (HDHP). In 2017, an HDHP requires a minimum annual deductible amount and a maximum limit on the sum of the annual deductible and out-of-pocket medical expenses. In 2017, the requirement is $1,300 and $6,550 for a self-only coverage, $2,600 and $13,100 for a family coverage, respectively. Certain additional rules and exceptions may apply. You could learn more about here. It tells you how to figure out your own contribution limit based on your specific situation.
You should easily be able to tell which health insurance plan is HSA eligible from the name of the plan. Otherwise, simply ask your insurance agent or the insurance company directly.
Who is this best for?
In general, a higher deductible and a higher limit on out-of-pocket expenses make an HDHP cheaper than non-HDHPs. However, if you regularly incur a lot of medical expenses every year, it may make more sense to have a non-HDHP with better health insurance coverage. It really depends on your specific situation and how the numbers work out for you.
The general answer is that the combination of HDHPs and HSAs are usually best for people who do not expect a lot of medical expenses in the following year.
How can I open one?
Like opening an IRA, you don’t need to file any forms with the IRS when you open an HSA account. However, you must file Form 8889 with your federal income tax return if there is any activity including contributions in your HSA during the tax year.
You can open and make contributions to an HSA for the current tax year until the tax-filing deadline (usually April 15) of the following year. In other words, you still have time to open and contribute to an HSA for 2017 until April 18, 2018. Also, based on the last-month rule directly form the IRS here, even you are not eligible for HSAs in all 12 months in 2017, as long as you become eligible and remain eligible for it from December 1, 2017 until December 31, 2018, you are still eligible for the maximum contribution in 2017($3,400 for individual coverage and $6,750 for family coverage).
HSA providers are relatively limited. Each of them has different features, fees, interest rates and investment options. There are many great resources online like this and this may help you find the best HSA for you. You should make your own decision based on your specific situation.
Again, 2018 open enrollment period ends on December 15, 2017. It is time to shop for your health insurance. Just keep in mind that there is another thing called Health Savings Accounts (HSAs). It is definitely worth considering. It may not work for you this year, but it may be beneficial in the future. For people who get health insurance through work, you could check with your HR department and ask them whether your current plan is eligible for HSAs and whether they offer any additional HSA benefits.