Why Investing in an HSA Makes Sense
In order to have an HSA you must have a high deductible health care plan. High deductible health care plans (HDHP) represent what insurance is supposed to be. Insurance of any form exists to limit financial exposure if unlikely, but severe outcomes occur. The more unlikely the event, the lower the cost of insurance. Typical “major medical” insurance that is often offered through employers to full time employees is not really insurance. Because routine costs are covered and deductibles are relatively low, the plans cost more. While it is likely that events will occur that cause over $500 a year in health care costs, it is very unlikely that events will occur that incur over $5,000 in health care costs. High deductible health care plans make sense for most young people, people in relatively good health and for children.
As an example, as a healthy non-smoking 25 year male, at ehealthinsurance.com, a plan with a $5,000 deductible costs roughly $75 a month, while a plan with a $500 deductible costs over $225 a month. The bet with a HDHP is that you believe it is unlikely that you will incur major medical costs. The insurance exists to limit exposure. In the above example, the HDHP limits exposure to $5,000 total. Get hit by a car and have $50,000 in medical bills? Only $5,000 of that is your responsibility. Since it is unlikely this will happen, every month over $150 is saved by going with the cheaper plan.
The real beauty of the HDHP is that they usually can be paired with a Health Savings Account (HSA). An HSA is a tax advantaged account where individuals can save money pre-tax for medical expenses, and the money comes out, tax free for qualified medical expenses, which includes expenses usually not covered by insurance. This makes an HSA a more valuable tool than a traditional IRA or a Roth IRA. There is a penalty of 20%, plus taxes owed if money is withdrawn for reasons other than medical expenses. HSA funds can be invested just like funds in an IRA, and at age 65, the penalty for using funds for reasons other than medical goes away, and money can be withdrawn as if the account is a traditional IRA (taxes must be paid on these withdrawals) The limits for HSA accounts are currently $6450 for family plans and $3250 for individual plans.
Because health savings accounts are tax deferred, they do hold a larger benefit for higher earners. Someone who maxes a family plan in the 15% bracket saves almost $1,000 a year, while someone in the 33% bracket saves over $2,100 a year. In most states HSA contributions are also deductible from state income tax.
Because contributions to an HSA lower your adjusted gross income, contributing helps qualify for the Retirement Savers Tax Credit and for Obamacare insurance subsidies, which are based off of AGI.
There is one more advantage of an HSA that can be a disadvantage depending on the situation. Only for people who have a HDHP and an HSA through their employer, and have the employer deduct from their paycheck money for their HSA, Social security and medicare tax is deductible. This adds an additional 7.65% tax advantage to the consumer. The caveat to this is that taking this deduction reduces social security wages, and for those who are in a lower income bracket, taking this deduction may greatly reduce future social security earnings. I do not recommend contributing to an HSA through an employer deduction unless income is above $57,000.
Social security is a progressive program that is heavily weighted on lower incomes. To determine social security benefits, SSA takes your highest earning 35 years, divides to get the average inflation indexed monthly wage, and calculates your benefit from that number, which is referred to as your PIA. Currently Social Security has 3 bend points based off of this monthly average wage number that determines Social Security Benefits. Earnings of up to $791 per month receive 90% of the PIA amount. The second bend point is $4,761 a month. Between these two bend points 32% of PIA is added to the monthly total and after this amount only 15% is added. This is why unless someone has average yearly earnings of over $57,000, I do not recommend funding an HSA through employer deductions, because it will otherwise greatly reduce future social security benefits. It is also important to note that employees are not required to use the HSA offered by their employers, you are free to choose from any administrator to be the custodian of your HSA. For more on how Social Security is calculated, check out my article on Optimizing Social Security Benefits.
Once more details come to light I will write an article on using an HSA through the Obamacare exchanges. I personally have a family HDHP that I purchased through ehealthinsurance.com , with an HSA from Health Savings Administrators. Although the paperwork does take some time to fill out, it is well worth it. Run the numbers to see if an HSA will work for you. I think all in all I spent about 5 hours buying insurance, setting up an HSA and the investment options and setting up a direct deposit from my bank to my HSA.
HSA Administrators is the only HSA that offers Vanguard funds. The vast majority of HSA custodians are essentially just savings accounts that offer little to no investing options. HSA Administrators offers 22 Vanguard funds that require no minimums to get started, and many of these funds are admiral shares, which have lower costs than normal shares (Most investors must have $50,000 to $100,000 invested to get these lower costs).
An HSA is a powerful wealth building tool and is the most essential retirement wealth building tool available, And I highly recommend that people in good health, especially those with a long time before retirement, use these accounts as a primary savings vehicle.
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