Recent surprises included a letter from my “retirement” company, in which they informed me that my next-year’s premium for health insurance would more than double the amount I paid last year. Although the premium was not cheap, it is absurd. As the baby boomers enter the final stages of their lives, I can see that my health insurance costs will only go up.
This is not a long-term political issue about how Medicare will be funded. It’s a problem that affects me, and it will affect you. Although it may not be the best way to pay for your medical bills, you should consider using a Health Savings Account (HSA). Small businesses face the greatest problem today: the availability and cost of healthcare. A small business can provide some coverage to its employees or an individual who is an independent contractor can use an HSA to pay for their own health care. This will explain the basics of HSAs and give you an example of how they might be beneficial to your business.
The Health Savings Accounts can be used in the same way as IRA’s and 401k’s. They allow you to save money on a tax-deferred basis. However, there are some restrictions and they must be managed by an IRS approved trustee (usually a bank or mutual fund). You must use them in conjunction with a High-Deductible Health Plan (HDHP). Generally speaking, an HSA should be used first to pay for your medical expenses. The HDHP will kick in to pay for any medical expenses beyond the high deductible threshold.
These are the details. You must first buy an HDHP with a minimum $1,050 (for a family of two) and a maximum $5,250 (for a family of three). You will not be able to open an HSA if you don’t have one. This is because the safety valve that covers extraordinary medical expenses in any given year is essential. You can then set up an HSA with a financial institution in the same manner as you would for an IRA. You can contribute up to the lower of your HDHP deductible, which is $2,700 for an individual or $5450 for a couple. These amounts are not subject to tax and you can deduct them from your taxable income when you file your taxes. The government now pays a portion of your medical bills.
To pay your medical bills, you can withdraw from the HSA. Your policy will begin to cover your medical expenses if your medical expenses exceed your HDHP deductible. If you have any funds in your HSA that are not used by you at the end, they will roll forward and be available for you to use in future years. This means that if your family opened an HSA with $5.450 in year 1, and you only incurred $3,000 in medical expenses in that year, $2.450 would still be available to use in the next years. Contributions in previous years are also allowed. This is the second benefit to an HSA. There is no “use it or lose it” clause in these accounts. If you and your family are healthy, it can be a great way to build up a reserve for unexpected medical expenses in the future. An HSA’s third benefit is that the income you earn in the account is also deferred tax – just like an IRA.
Drawdowns from an HSA aren’t taxable as long as they are used for medical expenses. However, they can’t be used to pay the HDHP Premium unless you are unemployed. You will be subject to a 10% penalty if withdrawals are made for any other than medical purposes.
These accounts should be considered carefully based on your age. To make contributions to an HSA, you must be younger than 65. If you’re 65 or older, you can still receive Medicare but cannot contribute to an HSA. If you are between 56 and 64 years old, you can contribute an additional tax-deferred “catch up” amount of $700 in 2006, increasing incrementally to $1,000 in 2009. When you reach 65, your HSA will convert to an IRA. However, withdrawals for medical expenses are not subject to tax. Experts agree that these accounts may not be as beneficial for older workers. One of the advantages of an HSA account is the ability to build up your account balance for future medical expenses. The more you age, the easier it will be to do this.
HSAs can be used by small businesses to offer basic medical coverage to their employees. While the employee must still have an HDHP in order to be eligible, both employees and employers can contribute tax-deferred to the account. An HSA allows employees to take their account with them if they leave the company. HSAs are not available to employees. The company doesn’t have control over the way employees use the money. The company does not have any legal rights to stop employees from using the money for anything other than to purchase a car or vacation. However, taxes and penalties will be imposed on those who withdraw the funds. It’s clear that the money was not intended if it came from your company.
The math involved in comparing an HSA to traditional health insurance plans will vary depending on the individual, but some people find it compelling. Let’s say you are forty years old and pay $1,000 per month for your health insurance. You also have to pay $2,000 annually in co-pays and deductibles. This makes an annual total of $14,000 after taxes. You can also purchase a $500 monthly deductible HDHP, which costs $500, and put $5,000 into an HSA. This will incur $3,000 in out-of-pocket medical expenses. This means that you have incurred $9,000 in out-of-pocket medical expenses ($6,000 for the HDHP, $3,000 for other expenses), and the tax deduction of $5,000 in your HSA. There are $2,000 in tax-deferred funds which can be carried forward for future years.
It is obvious that the math doesn’t work in all cases and each person must consider their particular situation. HSA’s may not be a great deal for everyone, but they are. Shame on you, and shame on the system, if your medical expenses rise every year. Shame on you if you waste money because you didn’t have the time to look into whether an HSA would be beneficial.
