It’s fall, and that means open enrollment time for workplace benefits as well as Affordable Care Act (ACA) coverage. When you’re reviewing your health plan options, don’t overlook the benefits of a high deductible health plan (HDHP).
What is a high deductible health plan?
As the name suggests, an HDHP is a health insurance plan with a high deductible, which is the amount you must first pay out of pocket for medical expenses before insurance coverage kicks in. The IRS determines minimum deductibles and maximum out-of-pocket expenses for HDHPs each year. To qualify as an HDHP for 2020 and 2021, a plan must have a deductible of at least $1,400 for individuals and $2,800 for families. Out-of-pocket costs are limited to $6,900 for an individual or $13,800 for a family in 2020; in 2021 these limits rise to $7,000 and $14,000, respectively.
Why would I want a high deductible?
The first thing you might notice about an HDHP (other than the high deductible) is that monthly premiums are relatively low. Because deductibles are high, insurers can provide coverage for less. Particularly if you’re a young, healthy person who doesn’t use a lot of health care services, the premium savings alone might be enough reason to choose an HDHP. The greater benefit, however, is the opportunity to contribute to a health savings account (HSA).
What is an HSA?
An HSA is a savings account that allows you to pay for qualified medical expenses tax free, even if you don’t itemize deductions. Account holders, their employers, or anyone else can contribute to an HSA, and funds in the account grow tax-free as well. As long as you use your HSA funds only for qualified medical expenses, you never owe taxes on your deposits or the income they earn.
Who can open an HSA?
To open an HSA, IRS rules require that in addition to coverage by an HDHP, individuals must not have other health coverage (with certain exceptions), not be enrolled in Medicare, and not be able to be claimed as a dependent on someone else’s tax return. Once you turn 65, you may no longer contribute to your HSA, but the funds can continue to grow and be used for medical expenses tax free.
How does an HSA work?
Your employer may sponsor an HSA, or you can set one up for yourself. Often, an employer-sponsored HSA is an attractive choice because contributions are deposited pre tax, either as a paycheck deduction or a contribution directly from the employer. If your employer doesn’t sponsor an HSA, then you’ll need to do some shopping. Many institutions offer HSAs for individuals, and HSAs come with a variety of fees, requirements, and investment options, so it’s important to compare features before choosing where to open your account.
When you deposit funds to an HSA that is not employer sponsored, you get the tax benefit at the end of the year by claiming a deduction when you file your tax return. You can deduct any after-tax contributions that you make to your own HSA, up to the annual limit, from your gross income when you file your taxes. For 2020, contribution limits are $3,550 for individual accounts and $7,100 for family accounts; in 2021, these limits increase to $3,600 and $7,200.
Can I use my HSA for non-medical expenses?
An additional benefit of an HSA is that you can also use it as a retirement account. In fact, doing so has some advantages over having just a 401(k) or IRA. First, these more traditional retirement accounts require you to make withdrawals at a certain age, while you can let your HSA funds grow as long as you don’t need them. Additionally, 401(k) and traditional IRA withdrawals are subject to income tax, no matter how they’re used. Having an HSA in place during retirement allows you to continue paying for all of your qualifying medical expenses tax free. Other withdrawals will still be subject to regular income tax.
It’s important to note, however, that using your HSA funds for non-medical expenses before you turn 65 can cost you a 20% IRS penalty. For this reason, it’s very important that you understand what counts as qualifying medical expenses for your HSA purposes. If you accidentally use your HSA for nonqualifying expenses, you may be able to return the money to the HSA before the tax filing deadline and avoid the penalty. The IRS allows you to correct “mistaken distributions” if they are due to a reasonable cause, but be aware that plan custodians don’t have to accept returns of mistaken distributions.
When you’re deciding what benefits to sign up for during open enrollment, consider the benefits of an HSA-eligible HDHP. Rather than choosing a plan with a lower deductible and a higher monthly premium, you could choose a higher deductible plan with a lower monthly premium and deposit the difference in your HSA and let it go to work for you. Just make sure to have a plan to cover the high deductible and out-of-pocket maximums in case of unforeseen medical expenses.
Boelman Shaw provides tax and financial planning services to help our clients get the most from their money. Subscribe to our blog for regular updates on our latest articles.
Material discussed herewith is meant for general illustration and/or informational purposes only, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice.