Financial Abundance

With inflation exceeding 5%, are you searching for ways to cut expenses and save for retirement? While often overlooked, the Health Savings Account (HSA) can significantly lower your health care costs and provide a tax-free way to save for retirement.

For you health insurance needs, you should consider the combination of a High Deductible Health Plan (HDHP) with an HSA. These health insurance plans are often undersold by insurance agents due to the lower commissions they receive. However, when compared to a traditional health insurance plan, the HDHP/HSA combination will virtually always reduce your health care costs.

The HDHP/HSA combination is often characterized as only being advantageous for the healthy and the wealthy. This assertion is wrong! As long as you contribute the maximum annual amount to your HSA, the HDHP will virtually always save you money on your health care costs, regardless of your health care expenses.

An HDHP/HSA provides three financial advantages over a traditional health insurance policy:

1) If a traditional health care plan, with a $1,500 family deductible, costs $400 per month, an HDHP, with a $4,000 family deductible, will typically cost around 25% less or $300 per month. In this example, the HDHP provides a $1200 per year savings on insurance premiums.

2) When you contribute the family maximum to your HSA, a $5,800 tax deduction is applied to both federal and Colorado income taxes. If family taxable income exceeds $65,100, all incremental income is taxed at 25% for federal income taxes and 4.63% for Colorado state income taxes. The $5,800 maximum HSA deduction provides a combined federal and state income tax savings of $1,718.50.

3) Medical expenses paid from your HSA are made with tax-free dollars. With a traditional health plan, all expenses are paid in after tax dollars. Thus, paying the traditional plan’s $1,500 family deductible will require before tax earnings of $2,132.

Let’s assume that your health care costs exceed $4,000 in 2008. On an after tax basis, the traditional health insurance plan’s deductible will save you $1,868 over the $4,000 HSA deductible. However, HDHP premiums are $1,200 less and the HSA deposit saves you $1,718.50 in federal and state income taxes. Combining both the premium and income tax savings, the HDHP/HSA plan costs $1050.50 less than a traditional health insurance plan, at the maximum HDHP deductible amount of $4,000. HDHP plans also have no co-pays and often pay 100% of all medical expenses after the deductible is met.

If your family is healthy and you only require $1,000 in medical expenses for the year, the annual after tax savings with the HDHP is $3,340. This represents the sum of the HDHP insurance premium savings, the HSA income tax savings and $421 saved by paying the $1,000 in medical expenses with HSA funds that are never taxed.

An HSA is the only savings device that combines the income tax savings of an IRA with the tax free withdrawal of a Roth IRA. Like an IRA, funds deposited into an HSA are completely deductible from your income taxes, even if you don’t itemize. Like a Roth IRA, HSA funds can be withdrawn tax free at any time, to pay for medical expenses.

If your finances will allow, use current income to pay medical expenses and save your HSA funds until retirement. The Employee Benefit Research Institute estimates that a 65 year old will require $164,000 in medical expenses if they live 20 years after retirement. With HSA funds growing tax free, you could potentially have “free” medical care throughout your retirement years.

As long as you fully fund your HSA account and are in at least the 25% federal income tax bracket, you will virtually always come out ahead with the HDHP/HSA. When it comes time to renew your health insurance coverage, consider the HDHP/HSA approach. It will save you money and it can provide an excellent savings vehicle for your retirement years.