By William G. (Bill) Stuart
Director of Strategy and Compliance
Benefit Strategies LLC
Are you offering an HSA program to your employees?
If not, here are three good reasons to think about this approach:
- Employers and employees save on premiums (sometimes without taking on additional out-of-pocket responsibility).
- Employers and employees reduce their tax burdens.
- Employees build equity to purchase future medical and health-related services.
Let’s look at each of these benefit areas in more detail.
All services except select preventive care are subject to the deductible on an HSA-qualified medical plan. While these plans have the broadest deductible in the market (many other deductible plans cover office visits and prescription drugs subject to a copay), the deductible can be as low as $1,300 for self-only and $2,600 for family coverage. Those figures are in line with the average deductibles for group health plans nationally ($1,318 among workers with a deductible and $1,077 among all workers with single coverage, according to a recent survey) and lower than average deductibles in the small-group and nongroup markets nationally and in New England.
Are HSA-qualified plans merely “watered-down” coverage, as some critics contend? Hardly. Yes, patients must meet a deductible before the insurer begins to pay claims – as with any deductible plan. HSA-qualified plans are typically less likely to have network restrictions increasingly common with other plans. HSA plans offer comprehensive benefits on par with other deductible and non-deductible plans and follow Affordable Care Act, or ACA, requirements that select preventive services be covered at no cost at the point of service or purchase.
HSA-qualified plans carry lower premiums than other plans with similar deductible levels not because they reduce benefits or physician choice, but rather because HSA-qualified plan enrollees self-insure more services (including physician visits and prescription drugs).
As consumers, we self-insure every time we don’t purchase the extended warranty when we purchase a cell phone or lawnmower, or we choose not to purchase flight insurance to receive a refund of our air fare if we can’t travel for certain reasons. Most consumers come out ahead financially over time when they don’t insure against smaller financial risks, while some wish with a specific loss that they’d purchased coverage.
The point here is that for a lower premium than for a plan with a deductible of the same dollar figure that’s less broad, individuals can enjoy the other benefits associated with an HSA.
One challenge is whether the medical insurer prices the HSA-qualified plan at a premium that’s meaningfully lower than a plan with a less broad deductible. In many cases, conservative actuaries haven’t created a meaningful spread in the cost of these plans to make them more attractive to employers and employees. (In an upcoming post, we’ll discuss how employers can price medical plan options to create a meaningful difference in employee contribution to premium.)
Employers and employees reduce their tax burdens
Employers can enhance employee enrollment in HSA-qualified medical plans by offering an employer contribution to each employee’s HSA. This contribution reduces the employees’ net deductible responsibility and, if the employer contributes early in the year, reduces the potential cash-flow issue that an employee faces with high out-of-pocket expenses early in the plan year. Employers deduct these contributions from their taxable income as deductible employee compensation.
Employees reduce their taxable income dollar-for-dollar with every contribution that they make to their HSA. Their contributions reduce federal income taxes and, if applicable, state income taxes as well. For a family with taxable income of, say, $85,000, the federal marginal income tax rate is 25%. If that family contributes $5,000 for a family contract (less than the limit of $6,750 from all sources in 2016 and 2017), its federal income tax savings alone are $1,250. That’s an additional $1,250 available to pay medical, dental and vision expenses. A 5% state income tax rate would boost the savings to $1,500.
Any contributions that employees make through their employer’s pre-tax payroll deduction program (called a Section 125 Plan or Cafeteria Plan) aren’t subject to federal FICA taxes either. Employer and employee each save $382 with that $5,000 contribution.
Let’s summarize the tax savings for the employee who contributes $5,000 to his HSA:
$ 1,250 Federal income tax savings
$ 250 State income tax savings
$ 382 Federal FICA payroll tax savings
$ 1,882 Total tax savings
That’s nearly $1,900 a year, or nearly $160 a month, that an accountholder might otherwise have paid in federal and state income taxes. (We use the word “might” to reflect the fact that perhaps the individual might have been able to find another means of shielding that income from taxes.) Thus, tax savings alone free up sufficient cash to cover nearly half the $4,000 deductible of a typical family medical policy.
What’s not to love about tax savings? HSAs give you control over more of your money, allowing you to spend it on your family and your priorities. HSA contributions are a great financial liberator!
Employees build equity to purchase future medical and health-related services
Individuals understand the concept of self-insuring (explained above): If they forego the extended warranties and instead save those potential premium dollars in a dedicated account, they’ll find that at the end of their lives, they most likely have a positive balance in that account. In other words, by purchasing less insurance and assuming more potential financial responsibility for small losses, they build equity that they can apply to any losses that the foregone insurance would have covered – or anything else they want to enjoy.
And so it is in an HSA program. Employees accept a higher level of medical self-insurance with a broader deductible. Their employer typically helps them mitigate the risk, particularly in the early years, with an employer contribution to their HSAs. Instead of sending more money to the insurance company to purchase additional insurance (payment of claims), employers and employees retain that additional money to purchase medical services in the immediate or distant future.
That’s right, the distant future. Since HSAs aren’t subject to a use-it-or-lose provision, accountholders roll over balances and can accumulate substantial equity in an HSA. Let’s look at a simple example:
Patrick saves $3,000 per year in his HSA. This figure is achievable whether he’s enrolled in self-only coverage (with a $3,350 contribution limit in 2016 and $3,400 in 2017) or family coverage ($6,750 each year). After 20 years of $3,000 annual contributions and 5% growth through mutual fund investments, he accumulates a balance of just over $100,000, thanks to compound growth and the absence of annual taxes due on the account gains. If he continues to contribute the same $3,000 for 10 more years, his balance grows to slightly more than $200,000. If he elects to stop contributing after 20 years and retains his balances, his account grows to $165,000. That’s right – even if he stops contributing, his assets don’t stop working for him.
Of course, all investments are subject to market risk. The figures above assume an annualized return of 6% on HSA assets – a conservative figure given the approximately 8% annualized return that the stock market has delivered during the last 100 years.
Patrick can also make the same contribution to his qualified retirement plan, like a 401(k). He reduces his taxable income by the same amount and enjoys tax-free growth within the account. That tax-free growth, whether in a qualified retirement plan or HSA, turbocharges account growth, since the annual earnings aren’t subject to income taxes as they are with, say, a traditional mutual fund.
Here’s the difference: Let’s fast-forward to retirement, when Patrick goes to pay his first Medicare Part B premium. We don’t know his actual premium, since it’s adjusted annually and increases depending on income. Let’s say it’s $200. His $200 Part P premium is deducted monthly from his first monthly Social Security check. So, he needs to withdraw $200 from savings to cover his monthly expenses. If he withdraws the funds from his HSA, he distributes only $200 because distributions form an HSA for eligible medical expenses, including Medicare premiums, are tax-free. If he pays with 401(k) funds, though, he must withdraw $267. The additional $67 covers his taxes, since all distributions from a 401(k), even withdrawals for necessary expenses like Medicare premiums, are taxable.
That’s the power of an HSA.
In closing, here are the relevant questions that benefits decision-makers need to ask when crafting their benefits strategy:
- Do I want to see my employees and the company pay less in premiums to our insurance carrier?
- Do I want my employees and the company to pay less in taxes and thus to have more to spend on their priorities?
- Do I want to help my employees build equity?
If you’re en employer and you answered yes to these questions, it’s time to speak to your benefits advisor about the advantages of an HSA program.
If you’re a benefits advisor, you need to be asking your clients these questions – before a competitor does!
If you’re either an employer or a benefits advisor, you can ask Benefit Strategies to help you with implementation strategies and best practices, answer your questions about HSA rules and collaborate on a communication strategy to employees. This is our business, and we have a great deal of experience helping employers and benefits advisors design and navigate an attractive HSA program.
Finally, if you happen to be an employee and your employer doesn’t offer the HSA opportunity to you and your co-workers, you should be asking your employer, “Why not?”
What We’re Reading This Week
Michael Cannon, the director of health policy studies at the Cato Institute, recently had a frustrating experience as a patient as he tried to determine whether or not to undergo a common preventive procedure and his potential financial responsibility. He’s not alone in trying to be a good medical consumer in a confusing system. Read about his experience here.
As we explained in an earlier post, individuals who purchase medical coverage through the state or federal exchanges are in for sticker shock this year. The Kaiser Family Foundation, an excellent unbiased source of information, has the story here. Bob Laszewski, whom we’ve quoted in this space before, says we’re reaching a crisis point in coverage in the nongroup market here. Depending on your political persuasion, you can learn more from Fox News or CBS News. The American Academy of Actuaries provides an analysis of why premiums are increasing here.
Earlier this year, the Dept. of Labor issues new rules for individuals and institutions that act in a fiduciary capacity. Congress has a right to vote to overturn regulations issued by the executive branch, and Congress did so. President Obama vetoed the legislation, thus upholding his administration’s new rules. You can read more about the issue here. Benefit Strategies doesn’t offer legal advice, but we try to keep you up-to-date on issues that may impact your benefits program. You may have advisors working directly or indirectly on your behalf who are impacted by these new rules.
Have you tried telemedicine yet? A growing number of medical insurance policies now include this benefit. You can engage directly with an MD via an audio or video connection. It’s a convenient and inexpensive method of receiving primary care for simple conditions. Check with your insurer to see whether your employees have access to this benefit. To learn more about telemedicine, click here.