Updated on 08/30/2022
[Thanks for visiting my blog! You can find the website disclosure statement here. Please not this post does not constitute investment or insurance advice and is educational only.]
A Stroll Down The HSA Lane
Born out of a broken US healthcare system and its accompanying high-deductible health insurance plans (HDHPs), the HSA offers the ability to save in a triple tax-advantaged manner. How? The HSA bypasses FICA & Medicare taxes, grants tax-deferred contributions and growth, and allows tax-free withdrawals to cover medical expenses.
However, if you want to fund an HSA, you must have an HDHP. And unfortunately, HDHPs can get expensive quickly. Over the past four years, I had out-of-pocket medical expenses that exceeded $14,000.
Fortunately, my health has improved, and I am looking at a less expensive and more mobile future where mountain biking and hiking are frequent again.
But, I am not here to discuss my health. Instead, I am here to discuss why I saved in an HSA over a lower deductible plan, given the costs I faced.
Crunching the numbers
Finance is an emotional and numerical endeavor. But, separating these two characteristics can be complex. Still, if we can learn how to use logic to overcome emotions, we may become wealthier.
You see, when deciding between an HSA eligible HDHP and a lower deductible health plan (HP), we must weigh five different inputs:
- The monthly premium
- Deductible/co-insurance amounts
- Maximum out-of-pocket spending
- Tax savings
- Your predicted medical situation
By leveraging these five inputs, we can determine whether or not an HSA eligible HDHP makes sense over any lower-cost alternative. After all, saving money is one of the critical pillars of financial freedom!
If you prefer using an automated calculator, you can skip to the one I found on AARP’s website pictured above that is intuitive and then jump to the bottom of this blog post. For those wanting to understand the inputs better and how they tie together, proceed below!
Manual Inputs Explained
Your monthly premium is the cost of your health insurance plan. In essence, it is your required sunk cost to mitigate the risk of unlimited out-of-pocket medical expenses. Everyone pays in, few use it, and everyone benefits.
Now, your monthly premium will vary by your state, age, and employment status. Don’t smoke because if you do, your rates will go up while your life expectancy will drop.
To make subsequent comparisons more straightforward, I have annualized the monthly premiums for two plans offered by the same provider here in Colorado:
HDHP annual premium: $3,679.00
Non-HDHP annual premium: $4,993.00
Deductible & Co-Insurance
The next component is your deductible and co-insurance piece. Your deductible refers to the cost of treatment that you must pay BEFORE the insurance company covers anything (other than your annual checkup).
Co-insurance refers to the amount an insurance company will pay towards bills after your deductible is met. Sometimes, it is referred to as a co-payment, and in this case, it is a fixed dollar amount you pay towards each bill.
HDHP deductible & co-insurance: $7,000.00 & $0.00
Non-HDHP deductible & co-insurance: $1,400.00 & 30% co-insurance
The out-of-pocket maximum refers to the most you can pay each year for covered medical expenses. Unfortunately, some insurance plans have different maximums depending on whether a health provider is in-network or out-of-network.
Network status refers to whether the provider and insurance company have negotiated an agreeable cost for expenses.
HDHP deductible: $7,000.00
Non-HDHP deductible: $8,550.00
Tax Savings of HDHP’s
As I mentioned previously, HSA contributions are made before income taxes and, when deducted directly from payroll, exclude FICA & Medicare taxes.
Now, any savings had by using an HDHP plan will be determined by your tax bracket. If you are in the lowest bracket, 10%, and have no state income tax, you save $10 for every $100 contributed to an HSA. If you are in the highest tax bracket, 37%, and have a 4.55% state income tax, you save $41.55 for every $100 contributed to an HSA.
Importantly, you receive no tax savings with non-HDHP plans since you cannot contribute to an HSA.
7.65% FICA & Medicare taxes
22% Federal taxes
4.55% State taxes
Contribution allowed: $3,650 (single & under 55)
Equation: (FICA & Med+Fed+State)*Allowed Contribution = Savings
(0.22+0.0455+0.0765)*$3,650 = $1,248.30 in tax savings
Your Medical Situation
Your mileage will vary. Some years you will be healthy, others you may not. I never saw my medical issues coming, but fortunately, they have subsided after four trying years.
Unless you are chronically ill, you will have to gamble and guess what the next year holds. Generally, as you age, medical complications will increase, so plan accordingly. Additionally, medical costs vary based on the service type.
Putting it all together
So, for myself, if I were starting anew, here is what it would potentially cost me to either an HSA eligible HDHP or a lower deductible HP:
Scenario One: No medical issues
Total Cost HDHP: $3,679.00 – $1,248.30 = $2,430.7 (annual premium minus tax savings)
Total Cost Non-HDHP: $4,993.00 total (annual premium)
Scenario Two: Medical issues that cost $10,000.00
Total Cost HDHP: $7,000 + $0.00 + $3,679.00 -$1,248.30 = $9,447.80 (dedutcible + costs between deductible and out-of-pocket max + annual premium – tax savings)
Total Cost Non-HDHP: $1,400 + ($8,600*.3) +4993 = $8,973.00 (dedutcible + costs between deductible and out-of-pocket max + annual premium)
Scenario Three: Medical issues that cost $150,000
Total Cost HDHP: $7,000 + $0.00 + $3,679.00 -$1,231.20 = $9,430.70 (dedutcible + costs between deductible and out-of-pocket max + annual premium – tax savings)
Total Cost Non-HDHP: $1,400 + $7,150* +4993 = $13,543 (dedutcible + costs between deductible and out-of-pocket max + annual premium)
*In this situation, the maximum you can pay of the $150,000 bill is $8,550, so we use this total, rather than $148,600*.3.
Thus, in scenarios one and three, the HSA makes the most sense. However, in scenario two, the lower cost HP makes more sense.
Healthcare in the US gets expensive fast, which is why insurance is a blessing. Nevertheless, insurance is also a curse due to the high costs and headaches it can produce.
Save yourself money where you can by calculating what is best for your situation annually. When I am unsure what my medical costs will be, I generally take the gamble and enroll in an HDHP to save in my HSA. While there is the risk that I could pay more, I love that the HSA allows me to invest my money in a tax-deferred manner. Plus, if I am not ready to sell my investments, I can pay for medical bills with other funds and reimburse myself later when I decide to liquidate those holdings.
Notably, those in CA and NJ do not get tax-deferred growth in their HSA. Sorry, but write to your local regulators and complain!
I would love to hear in the comments below what you do for health insurance. Do you use an HDHP or lower-cost HP? If so, what is your reasoning for doing so? Please let me know, and as always, have a great day!
Mile High Finance Guy
finance demystified, one mountain at a time