How to Use Your Health Insurance to Save Money

I'm going to tell you about a government-approved, tax-favored program that could have you saving money on your healthcare expenses as soon as next month. This law lets you reclaim money that had been going into the health insurance company coffers. It offers you tax breaks. You could be using pre-tax dollars for some things that are not otherwise allowed to be included in your health care expenses deduction. You will have more flexibility and control over your health-related expenses than you ever thought possible, if you take advantage of what I'm about to tell you.

Wow! Just writing that down got me energized! It surprises me that what I'm writing about, though not a secret, is way under-utilized, and is misunderstood by the much of the public and health insurance agents alike.

You will see the real power of it once you put it into practice.

Now you should know, up front, that what I'm about to tell you wasn't designed for everyone. For instance, people who have ongoing medical problems - chronic conditions that keep them going back to the doctor or being admitted to the hospital on even a semi-regular basis - or people who have a hard time managing their own money are not good prospects for this program. It requires self-discipline in setting aside money into a special account. This special account has tax advantages - even if you don't itemize - but you must be able to keep the money separate from your spending accounts.

If you can do this, many opportunities open up for using this pre-tax money. You can buy things you never thought possible. Things like braces for your child - or any dental work. Things like eyeglasses and contact lenses. And many common purchases that you buy anyway can now be, in effect, tax-deductible.

Have you ever had a cold and bought some medications for the sniffles? Or - speaking of sniffles - allergy medicine? Pain relievers? Nicotine medications? Motion sickness pills? All of these qualify as eligible expenses!

Have you figured out what type of plan I'm talking about yet? I'm sure you've heard of it. President Bush mentioned it in many of his addresses to the nation. The major problem with the plan is it is not well understood, and that's my mission today.

The plan is known as an HSA. HSA stands for Health Savings Account, and it is more correctly referred to as HSA-compatible, meaning the plan fits the IRS rules which allow the owner to open an HSA account to take advantage of all the neat deductible things I've been talking about.

A little about the plans themselves: As I said in the beginning, they are not for everyone. If you go to the doctor a lot due to chronic or sever conditions, you don't want one of these plans because you would be paying more out-of-pocket than you would save with the lower premium.

And they do have lower premiums, generally. There are many different ones from many different companies, of course, so their premiums vary widely and are far too many to name them here. But the rules are the same for all of them, regardless of where you are.

The whole theory behind these accounts is this:

Higher deductibles equals lower premiums. The trick is to save the difference - put it into your pocket instead of the insurance company's. You've probably heard when it comes to life insurance the axiom to buy term and invest the difference. The principle is the same here. Only here, you are putting the difference (and more, really, up to a maximum of $5,950 annually for a family of two or more) into an HSA account. The money is deductible, on the front of the 1040 or 1040A and is what is known as an above-the-line deduction. (Ask you tax adviser as I am not in that business, but I've been assured that above-the-line is better than a Schedule A deduction.)

The trade-off: Lower premium (money saved) versus higher deductible (money out-of-pocket before the insurance starts paying its share).

So you see, if you are generally healthy and don't pay much in doctor bills or prescriptions, rather than paying a higher premium for coverage you won't take full advantage of, you pay a lower premium and save the difference (which, again, is deductible). The account savings is expected to be used to pay for doctor visits, dentist visits, et cetera . There is a whole list of eligible items that money can be spent on.

But here is the best part: Money that you don't use can accumulate and earn interest. The interest is also tax-free. And if you don't use the money in any given year (which you probably won't and don't want to anyway), it can be rolled over to the next year....and the next, and the next... Indefinitely. As long as you use it for eligible expenses, you never pay any taxes on the earnings, regardless of your income.

Be aware, though, that if you do use the money for non-qualified medical expenses, you not only get taxed on the money you use, but you also get hit with a 10% tax penalty. Once you reach 65, you no longer are required to use the money on medical-eligible expenses. You are now free to spend it on anything you want, as the 10% penalty no longer applies.

That's like an IRA. No, wait - it's better than an IRA. With a traditional IRA, if you deduct the contributions, you pay tax on the money when it is withdrawn. And you pay taxes on the earnings either way. With a Roth IRA, you don't pay taxes on withdrawals or earnings, but you weren't able to deduct the contributions. With the HSA, you get triple tax savings: (1) deduct the contributions, (2) tax free earnings, and (3) you don't pay tax on money withdrawn for qualified medical expenses.

Ah, so you smart ones who know about IRAs are thinking already, "With an IRA I can invest in mutual funds and earn a lot more than what the bank is going to pay interest on an account." And you'd be right. Except for one thing: With the HSA-compatible account, once you reach a minimum balance (usually $2,000), any additional contributions can be invested in mutual funds, just like an IRA.

Let me give you an hypothetical example of an HSA in action:

John enrolls in a PPO plan that is HSA-compatible, and simultaneously opens an HSA. The PPO has a deductible of $3,500. John can set aside up to $2,850 for 2009, but chooses to only put aside $2,500.

During the year, John has health-related expenses (doctor visits, medications, etc) of $1,000. Because his deductible is $3,500, John is responsible for all $1,000. This is how it would look:

Estimated Income Tax Reduction: $ 583

Amount Added to HSA: $2,500

Amount Paid From HSA: $1,000

Amount Remaining (Includes 3% interest): $1,545

The amount remaining in the HSA is carried over to the next year with no tax owed.

Now, suppose John continues to add $2,500 to his HSA for each of the following five years. During this time, John's expenses that he opts to pay out his HSA is $300 per year. Now his account would look like this:

Estimated Income Tax Reduction: $ 3,498

Amount Added to HSA: $15,000

Amount Paid From HSA: $ 2,500

Amount Remaining (Includes 3% interest): $13,625

It's looking pretty good for John, isn't it? Now, let's suppose in the seventh year, John has a fall on the basketball court and breaks his wrist. The total bill for this comes to $6,000. How would his account look now?

Estimated Income Tax Reduction: $ 4,081

Amount Paid Into HSA: $17,500

Amount Paid From HSA: $ 6,000

Amount Remaining (Includes 3% interest): $13,690

As you can see, that slowed John down some. But not all that much, because John only had to use $3,500 from his HSA to cover the deductible, and the health insurance policy paid the rest.

So, now that you know all about HSA-compatible health plans, what are you waiting for? If you have health insurance through your employer, call HR today and ask what your options are for changing your coverage. If they don't offer an HSA, or you don't have insurance through your employer, or you are an employer who wants to install an HSA-compatible health plan as part of your employee benefits package, contact me and I will be happy to help get you started.