Health Savings Accounts, or HSAs, and their attendant high-deductible health plans (HDHPs), have been embraced by over 10 million Americans. Consumers are looking for ways to keep premiums affordable, while businesses are looking for ways to control health care expenses. HSA/HDHP combinations have been immensely successful at containing the rate of growth in health care costs, reducing the rate of increase in medical insurance expenses to 2% per year, compared to the 12% rate of inflation in traditional major medical plans since 2000.
In return, however, workers and policy owners have had to pick up more of the risk – you can only use HSAs if your plan qualifies with a minimum deductible of $1,200 (or $2,400 for family plans.)
Advantages of HSAs and HDHPs
- Minor claims make up a big chunk of health expenditures in the U.S. When the insurance company doesn’t have to pay for sniffles, cuts and bruises, it can save its resources for truly severe medical incidents – and pass the savings on to the HDHP holder,
Income tax reduction. Any contributions to an HSA are not taxed as income. This reduces your net tax bill and increases total after-tax compensation to you.
Tax deferral. Any assets held in HSAs accumulate tax deferred. There is no income tax due on interest or dividends, nor is there any capital gains tax due if you sell holdings at a profit.
Improved rollover provisions. Unlike flexible savings accounts, you don’t lose HSA contributions at the end of the year. They can continue to grow, tax-deferred, indefinitely.
Tax-free distributions for qualified health care expenditures. There’s no income tax or penalties, provided you use the funds for medical expenses. However, a recent change to the law excludes over-the-counter medicines from the list of approved expenses.
Control. You as the policyholder can choose what you want to invest in within the HSA. Most plan administrators will allow you a variety of investment options, ranging from very conservative to aggressive.
Asset Protection. Assets held in HSAs are generally exempt from the claims of creditors in bankruptcy.
Disadvantages of HSAs and HDHPs
Potential for increased out-of-pocket costs.
- These plans work very well for the healthy. However, unless you have been funding your HSA, you will have to pay more out of pocket than for most health care plans, because of the higher deductibles.
Penalties for non-qualified expenses. In prior years, the penalty for using HSAs for nonqualified expenditures was 10 percent, which was in line with the early distribution penalties for other kinds of assets. However, the recent health care reform law doubled the penalty for non-qualified HAS distributions. In addition, you will have to declare the withdrawal as taxable income, though you may be able to offset this by claiming the medical expenses as a miscellaneous itemized deduction, to the extent the expenditure exceeds 7.5 percent of your income (or 10 percent of your income, if you are subject to the alternative minimum tax).
HSAs are not appropriate vehicles for general emergency funds, because of the draconian penalties.
Unsuitability for those with chronic medical conditions. Some individuals or families that deal with chronic, ongoing medical conditions may be better off in group plans with lower deductibles, spreading their routine, predictable expenditures among other members of the plan.
In a nutshell, HSAs and HDHPs tend to work best for people who tend to pay more in insurance premiums than they use in health care. However, every situation is different, and every business’s risk pool is different. There is no ‘one-size fits all’ solution. But an HSA/HDHP is a compelling alternative for the right set of circumstances.