What is a HSA/HDHP?
HSA/HDHP is a stands for “health savings account/high-deductible health plan”. In order to open a HSA, one has to be enrolled in a HDHP so the two really go hand-in-hand. Health Savings Accounts (HSA) were created in 2003 as a part of the Medicare Prescription Drug and Modernization Act. HDHP’s are health insurance plan’s with lower premiums and higher deductibles than traditional health plans.
More companies are moving to HSA/HDHPs. On average, the annual growth rate of participation in HSA/HDHP has been 15 percent. This figure is only expected to increase as a result of the recent health-care overhaul. Starting this year, 2014, most employers have to offer health insurance plans that are considered affordable and adequate. What employers’ have found, is that by offering HDHPs’, they can reduce their yearly health premium payments by up to 35%. Not only that, but HDHPs’ can save a company money in renewal fees as well. A recent PriceWaterhouseCoopers survey released in June 2013 found that 17% of employers now offer HDHP’s as their only option, up from 13% in 2012. Bottom line, expect to see more companies move to offering only HDHP’s in the future.
HSA’s are very similar to Individual Retirement Accounts (IRA’s) in that they are accounts that are set-up to allow one to save money on a tax-deferred basis until the money is needed, usually in retirement. The big difference is that HSA’s can only be used to pay for medical expenses. In a sense, they are Medical IRA’s.
HSA’s are also similar to a Flexible Spending Accounts (FSA). Both let you save pre-tax dollars to pay for future medical costs. The key differences: The contributions you make to a HSA never “expire”. You can roll your money over every year and let the balance build up if you don’t use it. Additionally, the HSA is yours to keep even if you leave your job for another employer. As mentioned, you have to be enrolled in a HDHP.
On the other hand, with a FSA, you can enroll in any health plan your employer offers. The caveat, you have to use it or lose it. Meaning any money you contribute to your FSA account has to be used in the year you contributed it or, if it goes unused, you lose that money. Also, if you leave your employer, your FSA is closed.
Bottom line, HSAs’ offer more flexibility than FSAs’ and could offer similar benefits as IRA’s.
The 3 BIG Benefits
The big three benefits of contributing to an employer sponsored HSA is that it is triple tax advantaged, meaning,
- Contributions are deducted from an employee’s pay tax free
- Earnings grow tax free, and
- Qualified distributions are tax exempt from federal income tax, Social Security and Medicare tax, and state income taxes (in most states)
The Fine Print
As is almost always the case, one needs to read and understand the small print when investigating an employer’s health benefit plan. Not all employer plans are equal and knowing what is and is not included in that plan is essential to making an intelligent savings decision. So, when does it make sense to contribute to a HSA vs FSA?
Understand your employer’s investment options. Many companies outsource the management of their HSA’s to third party companies. The investment options offered by these organizations can be as simple as offering a savings account with a minimal interest rate to as complicated as offering full brokerage services allowing one to invest in stocks, bonds and even options trading.
If your organization offers investment options that essentially amount to interest bearing savings accounts, then you need to take the time to understand your personal views of why you are contributing to a HSA. The obvious benefit is being able to roll your money over every year. You don’t have to worry about losing it if you don’t use it. But if you want to use it as a Medical IRA, then you will be losing money over time.
Why? Because the interest you would be receiving on your investment, especially given today’s very low interest rates, would not be able to keep up with inflation, much less keeping up with medical inflation. Competitive interest rates on bank HSAs’ is between 0.1% for accounts with low cash balances to 0.55% for accounts with cash balances over $25K. Unfortunately, the current US Inflation rate is 1.5% and healthcare inflation typically runs more double the US inflation rate. As of August 2013, it healthcare inflation was pegged at 4.5%. Putting hard earned money into a HSA with limited investment options is a money losing proposition. In this case, it’s better to spend the money in the year you make your contribution.
For the Smart Saver
Contributing to a health savings account, if used wisely, can be an excellent way to save additional money for retirement or medical emergencies tax free. In 2014, an individual can contribute up to $3,300 a year, while a family can contribute up to $6,550. Just remember, you also need to be enrolled in a high deductible insurance plan. These insurance plans have to have a minimum deductible of $1,250 for an individual or $2,500 for a family, to be considered a HDHP.