Insurance and Health Savings Accounts   Leave a comment

So I think I’ve wrapped up my discussion of retirement accounts. But there is one special account left to talk about: the health savings account (HSA). However, only those with a qualifying high deductible health plan can have a HSA. So I thought I’d first discuss insurance in general first.

When should you get insurance?

This is a basic exercise of probability, and most if not all people could just skip to the tl;dr at the bottom of this section (and I’m sure many people will have realized the conclusion by themselves. But I’m writing it down here for completeness).

First off, if you can just afford to pay for a disaster event out of pocket, you obviously don’t need insurance. So if you can afford to just buy a car in the event of a car accident (because you never want to buy a new car, and would rather buy a used one), then clearly, you don’t need collision/full body insurance (though of course, you’re legally required to have liability insurance). You should instead just take your chances (because your chances are pretty good that you won’t be in an accident) and you can avoid premiums for collision/full body insurance. And if you do need to replace your car, oh well, so be it. But again, that’s not likely.

The insurance company is in it for the long term, which means that they can actually realize the law of large numbers – despite the fact that whatever they are insuring is generally speaking a rare event, they’ll see enough of them such that they get close to seeing the true probability of the rare event.

The insurance companies know this, so they set up the fees charged to the customers such that the company has a positive expected profit. Which thereby means that you have a positive expected cost by enrolling in the insurance.

But you’re not in it for the long term like an insurance company is. Well you may be enrolling in the insurance for the rest of your life, but it’s not long term in the sense that typically what you’re buying insurance for will (hopefully) only occur a handful of times. So the only benefit you realize from buying insurance is reducing the cost of the low probability but extremely high cost event (loss of home, expensive medical surgery, etc.). By buying insurance, you increase the average value but decrease the variance of your costs.

Every insurance company will let you increase your premiums (which you are guaranteed to pay) to lower your deductible (your maximum out of pocket for any given year). You should with vary rare exceptions always get the highest deductible. Just add the deductible to your emergency fund, and hope that the low probability event never occurs. And if it does, just pull the money out of your emergency fund. This way, your guaranteed costs (premiums) are kept as low as possible, your emergency fund can earn some interest in a savings account (though admittedly, interest rates are terrible right now), and you’re still covered for the disaster events.

tl;dr – If you can afford out of pocket the disaster event that the insurance covers, then you don’t need insurance–don’t spend money on premiums. The disaster event should be a rare enough occurence anyway. If you can’t afford the disaster event, get the highest deductible insurance plan possible to reduce your premiums. Stick a sum of cash equal to the deductible in a savings account and let it earn interest, so it’s there if you need it, and otherwise earning a little money for you.

The HSA

The HSA is a special type of tax advantaged account that is only available to you if you have a qualifying high deductible health plan (HDHP).

If you set up the HDHP and HSA through your employer, you can contribute money through payroll. Your contributions are not only pre income tax, but pre-FICA tax as well. This means you’re saving another 7.65% in taxes (assuming you make less than $118,500 for 2015). And just like a 401k, this money can be invested in stocks, mutual funds, etc. Though unfortunately, the HSAs that I’ve seen people post about on forums have even worse fees than the typical 401k. It may get better over time, we’ll see.

Now seeing as the HSA is tied to a HDHP, it makes sense that you can only use HSA money tax free for health expenses. That is, when you have a health expense, you should save the receipt, and you can withdraw the money from your HSA penalty and tax free. But, here’s the interesting part: you can save that receipt and withdraw the amount at any time in the future, even decades after the expense was incurred. So if you had $100 in the HSA and had a doctor’s appointment that cost you $100, you could decide to just withdraw the money and let the account balance fall to zero. Or, you could let the $100 grow over 27 years, and assuming an 8% growth rate, seen it grow to ~8 times the original balance! (I’ve applied the rule of 72). And during this growth, you could withdraw the $100 at any time penalty free (though if you withdraw the $100 early during the growth, the final balance will be nowhere near $800). But, it gets even better. When you hit 62, you can withdraw from your HSA for any reason without any penalty (but you still owe income tax on the withdrawals). Hence, after you hit 62, it acts like a traditional IRA in terms of withdrawals.

This means that if you do enroll in a HDHP that offers an HSA, you can get more tax advantaged space! Take advantage of this if you can (though of course, the HDHP has to make sense for you. It should make sense for most people, as outlined above, but perhaps the particular HDHP offering an HSA doesn’t cover something another plan does). The contribution limit for 2015 is $3350 for single people and $6650 for families, with an additional catch up contribution of $1000 for people at least 55 years old. So the contribution limit is quite low compared to a 401k, and is still lower than that of an IRA, but remember – contributions to HSAs are pre-FICA tax, a 7.65% additional savings.

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Posted January 19, 2015 by Fiby in Uncategorized

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