A relative newcomer to the health insurance field, the High Deductible Health Plan (HDHP) first came on the scene in the early 2000s. Sometimes referred to as a Consumer Driven Health Plan (CDHP), this option was meant to make consumers more cost-conscious and careful about their health care choices. For instance, perhaps it would encourage people to use the Emergency Room only for true emergencies and seek less costly care for routine matters such as the flu or a sore throat. Because consumers are obliged to bear more of the financial burden, these plans have lower premiums and have steadily gained popularity with employers who offer health care coverage.
Fortunately, another piece of the puzzle is the Health Savings Account (HSA), a tax-advantaged vehicle for accumulating funds to cover these increased healthcare expenses. A person who is covered only by an HDHP meeting certain criteria is eligible to open an HSA. For 2016, the HDHP has to have at least a $1,300 deductible for individual coverage or $2,600 for a family, and an out-of-pocket limit of no more than $6,550 for one person or $13,000 per family.
Contributions to the HSA are tax-deductible (above the line) and withdrawals are income tax free if used for qualified medical expenses. If the money is taken out for any other purpose a 20% penalty applies, along with income tax. For an individual 65 or older there is no penalty, but taxes must be paid if funds are used for non-qualified spending.
Unlike other medical savings accounts, such as a Flexible Spending Account, the money in the HSA does not have to be spent by the end of the year; it can be left to accumulate until it is needed. Also, although many HSAs are sponsored by employers, and the employer might make a contribution each year, the account belongs to the employee and goes with the person if he or she changes jobs.
Given this favorable treatment, an HSA can be an excellent way to save for retirement, similar to an IRA. The maximum annual contribution for an individual is less than for an IRA, $3,350 in 2016, including employer contributions, but is increased by $1000 for those 55 and over. If the HDHP covers a family, the 2016 contribution limit is $6,750, also with the $1,000 catch-up provision for age 55 and above.
The money in the HSA can be invested in money market, stocks, bonds or other such products. If the funds are then used for eligible medical expenses, the HSA is better than a Roth IRA, having deductible contributions but no tax on withdrawals. Once a participant reaches age 65, the account functions like an IRA for non-medical expenses, with income tax due on withdrawals but there is no penalty. The other side of the coin is that persons who are age 65 and older (enrolled in Medicare) are no longer eligible to make contributions to the HSA, although existing balances within the account can be maintained.
With health care expenses expected to be a much greater burden for retirees, a wise strategy in your younger years is to pay as much of your medical expense as possible from funds outside your HSA and try to build up the account as a cushion for the future.