There’s no doubt about it. Health insurance is expensive and getting more so each year. Employers are passing more of the increasing costs on to employees, through increased deductibles, reduced benefits, or increased employee share of the premium cost.
The fastest growing type of employer-sponsored health insurance is the high deductible health plan (HDHP) combined with a health savings account (HSA). By January 2007, 4.5 million people were covered by these plans, an increase of 40 percent over 2006, and employer surveys indicate that many more may be created in the future. In fact, the U.S. Department of the Treasury predicts that 25 to 30 million people will be in these plans by 2010.
So why all the buzz? There are several reasons for the popularity of HDHP/HSAs. First, the premium for a HDHP is cheaper than for other types of health insurance because you have to pay more out of pocket-the minimum deductibles are $1,100 for singles and $2,200 for family coverage. But by combining the health insurance with an HSA, you can set aside funds on a before-tax basis to help pay for out-of-pocket costs cheaper. Employers can make part or all of the HSA contribution and employees can also contribute.
The second reason for the great interest in these plans, which are often called "consumer-driven," is that policymakers believe we will be more cost-conscious in health care decisions if our own money is at stake. For example, if you have $2,200 in your HSA, you can spend it on current health care or, if you can find some cheaper alternatives (e.g. generic prescription drugs), you’ll be able to keep the cost savings. If enough people buy into this, it could help to drive down health care spending, or at least slow the rate of growth.
An HSA is similar to a flexible spending arrangement (FSA) but has some significant differences. Funds held in an HSA are invested to earn investment income, and they can be carried over from year to year. Two significant disadvantages of FSAs are that contributions earn no investment return and must be completely expended during the tax year. The carryover feature of HSAs allows currently healthy employees to fund future, more expensive health care needs.
The tax benefits of HSAs are also significant. The contributions are made before tax, just like traditional deductible IRAs. However, they are more similar to Roth IRAs in that withdrawals of both invested principal and investment returns are tax-free, if used for qualified medical expenditures and retirement. This makes them more attractive than most other savings vehicles, at least for this specific financial purpose.
Until last year, the allowed annual contribution was only $1,000, just enough to cover the deductible, and not nearly enough to make them attractive alternatives to FSAs (which you can’t have at the same time). Fortunately, the Tax Relief and Health Care Act of 2006 increased the annual contribution limits to $2,850 for self-only and $5,650 for family, with annual catch up contributions of $700 for policyholders age 55 and over (all scheduled to increase with inflation). With this change, it is reasonably possible to use an HSA to build up wealth, like an IRA. In 2006, HSA accounts totaled $5.1 billion.
High deductible health plans with Health Savings Accounts should be attractive to relatively healthy families, particularly those in higher tax brackets. The premium savings on the HDHP will allow you to apply household funds to other important financial goals and the HSA will allow you to accumulate wealth in the most tax-efficient way.
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Vickie Bajtelsmit, Professor of Finance, Colorado State University College of Business, email@example.com