Nobody likes insurance companies, especially health insurance companies - P. J. O'Rourke
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One of the biggest financial challenges that people face is covering the high costs of their healthcare. Especially as people get older, healthcare costs tend to rise, and so having a nest egg set aside to cover some of your out-of-pocket health expenses can be crucial.
Health savings accounts (HSAs) were designed to help give people an incentive for setting money aside for future healthcare needs. As useful as HSAs are, however, there's one shortcoming in the way that they're set up that has limited their effectiveness. If lawmakers were to borrow a provision from a similar health-related tax break and apply it to HSAs, then it could open the door to millions more workers putting these accounts to good use.
How HSAs work
Lawmakers created health savings accounts in 2003 in order to help eligible health insurance policyholders set money aside to pay their healthcare costs on a tax-favored basis. The tax breaks that HSAs offer make the accounts among the most attractive for taxpayers.
Specifically, HSAs give you several tax benefits. Contributions to an HSA are deductible on your taxes without having to itemize, with limits in 2020 up to $3,550 for self-only insurance coverage and $7,100 for family coverage. You're then able to invest your HSA contributions without having to pay any tax on the dividends, gains, or other income that your HSA investments generate. When it comes time to spend the money, you can withdraw it without paying any taxes at all as long as the money goes toward any of the wide range of qualified medical expenses that make the IRS list.
Health savings accounts are also great long-term savings vehicles. You never have to worry about forfeiting your HSA money, because you can carry unspent funds forward for use in future years. Some employers are even generous enough to add money of their own to their workers' HSA accounts, making them even more attractive as health insurance options. In many ways, HSAs end up looking better even than most retirement plans.
The big downside of HSAs
Unfortunately, the biggest problem with health savings accounts is that there aren't that many people who are eligible to use them. That's because in order to get access to an HSA, you have to have health insurance that qualifies as a high deductible health plan (HDHP). The following requirements apply to HDHPs:
- The minimum deductible amount that you're required to cover up front for 2020 must be $1,400 for self-only coverage, or $2,800 for family coverage
- Out-of-pocket maximums are typically $6,900 for self-only coverage or $13,800 for families.
Those insurance terms confuse many people, but what it means in ordinary English is that in order to use an HSA right now, you have to have health insurance that doesn't really start covering you until you've already borne a substantial part of the up-front cost. These HDHPs can be great for those who are relatively healthy and don't have a lot of medical costs. But for those who have current medical conditions requiring ongoing treatment, HDHPs can be expensive.
Taking a page from flexible spending accounts
Because HDHPs can be too expensive for some, many people choose to go with more comprehensive health insurance coverage. Under current law, doing so precludes them from using HSAs.
However, there's no particular reason why this has to be the case. Flexible spending accounts have some similarities with HSAs, particularly being able to get a tax incentive for setting money aside for use on medical expenses. Unlike HSAs, though, FSAs work no matter what kind of insurance you have. The downside of FSAs is that most of them require you to forfeit unspent money each year, preventing their use as long-term savings vehicles.
If lawmakers took the best of both worlds from HSAs and FSAs, it could make it a lot easier for people to save for healthcare expenses. Allowing universal use of HSAs regardless of whether you have HDHP or regular insurance coverage would extend their benefits to a much wider audience.
Keep your eyes open
At present, there aren't any proposals on the table specifically to open up HSAs to broader use...
Source: Dan Caplinger, The Biggest Problem With Health Savings Accounts, The Motley Fool, February 28, 2020.