When choosing a health plan, “deductible” can be a scary word. Adding high — as in “High Deductible Health Plan” (HDHP) — can make it even scarier.

But HDHPs are becoming a more common option, both on the Health Insurance Marketplace and for people who get health insurance through their employer. And, despite that scary “high deductible” phrase, they are also gaining in popularity, because they typically have a lower monthly premium or employee contribution than other health plan options.

If you have a federally qualified HDHP, you can also save money on your taxes — if you make smart use of a tool known as a Health Savings Account (HSA).

What Is an HSA?

 

An HSA is one type of health spending account. Others include a Health Reimbursement Account (HRA) and a Flexible Spending Account (FSA). You can find information on all spending accounts in Highmark’s Spending Account Resource Center. If your Highmark health plan includes a spending account, you can also log in to your member website, and then click the Spending tab at the top of the page for more information.

If you’re enrolled in a federally qualified HDHP, an HSA isn’t just something to consider — it’s the key to getting the most value out of your health care coverage. In fact, using an HSA with your plan can effectively reduce your annual health care costs.

How? There is an above-the-line deduction for HSA contributions made. That means your taxable adjusted gross income is reduced for each dollar contributed to an HSA (regardless of whether you itemize other deductions). Therefore, no income tax is paid on money that you deposit into your HSA — and which you can then use to pay for your qualified medical expenses.

In 2016, HSA contributions can go up to $3,350 for individual coverage (just you) and up to $6,750 for family coverage (you + a spouse/domestic partner, children or family). If you are 55 or older, you can put an additional $1,000 beyond those amounts into your HSA as a “catch-up contribution.”

So, if you have $60,000 of taxable income in 2016 but make the maximum family coverage contribution to your HSA ($6,750), your adjusted gross income will be reduced so that you’ll only have to pay taxes on $53,250 of your income. In the 25 percent tax bracket, that means you potentially save nearly $1,700!

Income taxes involve many other variables, too, of course, but the bottom line is that saving money in an HSA to cover your out-of-pocket costs for health care will also put money back in your pocket.

To better understand how to get the most out of an HSA, let’s look at three strategies and examples.

Strategy 1: HSA Payroll Deduction to Cover Your Deductible

If you get health coverage through your employer and choose an HDHP that has an HSA option, your employer may make a contribution to your account — and allow you to contribute to the HSA yourself through convenient automatic payroll deductions.

One way to decide how much to deposit is to estimate your out-of-pocket health care costs for the year. By putting at least that much into your HSA, you’ll take away the stress of figuring out how to pay your share of your health care bills — and get tax benefits along the way.

To estimate your costs for the year ahead, start by reviewing your claims and health care costs from the previous year. Consider doctors’ visits, prescriptions and other care (e.g., physical therapy or chiropractic visits). Be sure to add in anything that might be unique to the year ahead, like having a baby or scheduling an elective surgery. Once you have a total, look at your health plan’s copay, deductible and coverage to determine how much of those expected expenses you’ll be responsible for paying.

Scenario: Sally

  • 32 years old, files taxes as “single,” is in the 25 percent income tax bracket
  • Employed by XYZ Inc., which offers employees a qualified HDHP with a $1,600 deductible
  • As part of its health benefits package, XYZ contributes $400 to Sally’s HSA
  • Paid twice a month (24 times a year) and can select automatic payroll deposit to fund her HSA

Woman with two girls playing with dogSally had an HDHP last year but did not deposit any of her own money into her HSA. She had a few minor illnesses and also sprained her ankle while playing with her nieces. With her plan’s coverage, she ended up being responsible for $930 of her total health care costs. The money that XYZ Inc. deposited into her HSA covered $400 — but she paid the remaining $530 from her personal checking account.

A family member told Sally about the tax advantages of making deposits into an HSA and also explained that HSA funds roll over year after year — so there is no danger of losing what you don’t use.

With that in mind, Sally decides that it would be smart to have enough deducted from her pay to make sure her HSA can cover her $1,600 deductible for the year. Since XYZ contributes $400 to her account, that means she has to deposit $1,200 — or $50 from each of her 24 paychecks.

That’s a little more than she’d like. But since the $1,200 will be deducted from her adjusted gross income and save her about $300 in taxes (at a 25 percent tax rate), she decides it’s worth it to not have to worry about how to cover her deductible if her pesky nieces do more damage and she has an unexpected medical bill.

Scenario 1: Sally Covers Her Deductible
Plan Deductible: $1,600.00
Employer Contribution to HSA: $400.00
HSA Deposits Needed From Sally to Cover Deductible: $1,200.00
Deposit per Paycheck (24) to Cover Deductible: $50.00
Estimated Tax Savings: $300.00

 

Strategy 2: Maximizing Tax Savings — and Investing

In the example above, if Sally wanted to maximize her HSA tax savings, she would divide her maximum annual HSA contribution ($3,350 as an individual in 2016) by the number of pay periods, and then have that much of each paycheck deposited to her HSA. Factoring in XYZ’s contribution ($400), Sally would have to deposit more than $120 per paycheck to her HSA ($2,950 divided by 24). That was too much for her budget — so “covering the deductible” was a better HSA strategy for her.

It’s important to match your HSA strategy to your health and financial needs. So let’s take a look at a different example where it makes sense to contribute the full amount. Since not all people have employer-sponsored plans like Sally, let’s also look at a scenario involving health insurance bought directly from Highmark.

Scenario 2: Dan and Cindy

      • 57 years old, married and file taxes jointly, household income in the 28 percent tax bracket
      • Self-employed: Dan is a successful handyman and Cindy manages the books and other aspects of his business
      • Bought HDHP family coverage with a $5,000 deductible from Highmark on the Health Insurance Marketplace
      • Income fluctuates during the year, so they try to keep everything on a monthly budget

Couple standing next to their RVDan and Cindy are healthy, get their preventive care every year and have minimal health care expenses. As the primary subscriber for their HDHP, Dan has had an HSA for two years, but he’s made only sporadic deposits so far.

A $5,000 deductible isn’t as scary to Dan and Cindy as it might be to some people — and taking on that high deductible this year meant that they were able to get one of the lowest monthly premiums available in their area.

Still, knowing that one major medical issue could put them on the hook for their plan’s entire $5,000 deductible, they decide to start making steady monthly contributions to Dan’s HSA so they’re prepared.

After doing a little research, Cindy finds two reasons to maximize their annual HSA contribution even above and beyond what it would take to cover their deductible.

First, since they are self-employed and cover the full Social Security and Medicare tax (as an employee, your employer pays half of those taxes), it is extremely beneficial for them to reduce their taxable income. The maximum contribution to Dan’s HSA in 2016 will reduce their taxable income by $7,750 — $6,750 for family coverage and another $1,000 “catch-up contribution” because Dan is over 55.

Second, Cindy finds out that they can also invest some of their HSA savings in mutual funds — so the money won’t just sit in their account if they don’t have medical expenses; it’ll earn money.

For monthly budgeting, Cindy calculates that they need to contribute $645.83 to the HSA each month ($7,750 divided by 12). Better yet, she discovers that Highmark’s member website lets them set up a monthly “steady contribution” transfer of that amount from Dan’s checking account to his HSA account.

Scenario 2: Dan and Cindy Maximize Tax Savings
Plan Deductible: $5,000.00
Maximum 2016 Contribution to HSA: $7,750.00
Monthly Steady Contribution to Reach Maximum: $645.83
Effective Annual Tax Savings (28 Percent Tax Bracket): $2,170.00

 

Strategy 3: Pay as You Go for Flexibility

Our first two examples involved making steady contributions to an HSA. That’s a smart way to save for anything — and when it comes to medical expenses, it’s reassuring to know that you already have money waiting in your account when a bill arrives.

But let’s be honest — many life situations make it hard to know whether you can afford to put aside a set amount every paycheck or every month. If that sounds like you, an HSA can still be useful. In fact, if your budget is stretched thin, the lower premium or employee contribution of an HDHP may be a good option — and putting money into your HSA as you need it to cover expenses will get you some of your money back in tax savings.

Scenario 3: Dave

        • 26 years old, files taxes as “single,” income in the 25 percent tax bracket
        • Just started a custom woodworking business, so he puts much of what he makes into buying equipment, supplies and other expenses; also works part-time at a coffee shop to supplement his income
        • Bought HDHP individual coverage with a $3,000 deductible from Highmark on the Health Insurance Marketplace
        • Generally healthy, but has some allergies and is susceptible to other sinus problems

Barista in coffee shopAt first, Dave wasn’t sure he could afford health insurance, but at his mom’s insistence, he stopped into a Highmark Direct store to explore his options. There, he learned about a Highmark HDHP with a $3,000 deductible that had a low premium. Better still, the store associate pointed out that he qualified for a subsidy through the Affordable Care Act that would bring down his monthly premium even further.

Although Dave understood the value of setting up an HSA with his HDHP, he also felt that, for now, any money left after paying his living expenses needed to go into his business — not sit in a savings account for health expenses.

Instead, he took a pay-as-you-go approach. He opened his HSA with a small $50 deposit. When a sinus problem drove him to an urgent care center one weekend — $135 total for the visit and medication — he kept his receipts. As soon as some money came in, he transferred enough into his HSA to reimburse himself — so he’d be able to deduct that $135 from his taxable income.

When he knew that he had expenses coming — such as his doctors’ appointments and allergy prescription in the spring — he checked his copay and deductible to figure what his out-of-pocket costs would be, put that amount into his HSA, and then used his convenient HSA debit card to pay what he owed.

By putting only what he needed into his HSA, Dave ended up depositing $1,280 during the year — effectively reducing the income taxes he owed by $320. That’s a nice sum he can use for his business or a well-deserved weekend getaway — or to create a little more “cushion” in his HSA for next year.

Scenario 3: Dave Pays as He Goes
Plan Deductible: $3,000.00
Qualified Medical Expenses During the Year: $1,230.00
Initial Deposit ($50) Plus Deposits to HSA to Reimburse/Cover Expenses: $1,280.00
Tax Savings at 25 Percent Tax Bracket: $320.00

 

If You Have an HDHP, Put Your HSA to Work for You

This article covers only three of the many strategies that can help you get the most out of your HDHP by using an HSA. Remember that once you open an HSA, that account is yours even if you change plans (although it’s only tax-deductible when you have an HDHP).

Your HSA can be a “safety net” in case you develop a costly health problem, a tax shelter or investment tool, a convenient way to pay for everyday health-and-wellness expenses, or all of the above. But the key takeaway here is that having an HDHP plan without an HSA is like having a car without tires!

If you’re a Highmark health plan member with a qualified HDHP and you don’t already have an HSA set up, just log in to your Highmark member website and click on the Spending tab to start funding your HSA. And you can always visit Highmark’s Spending Account Resource Center for more helpful information on HSAs, FSAs and HRAs.