How Federal Employees Can Reduce Out-of-Pocket Costs With Health Savings Accounts

During open season, federal employees and annuitants need to determine which health insurance plan offered through the Federal Employees Health Benefits (FEHB) program they want to be covered.  Among the most popular FEHB plans available to employees are preferred provider organizations (PPO) plans in which employees and annuitants have their choice of which doctors and hospitals they and their covered family members can use in case they need medical care. By using doctors and hospitals who are in the health plan network, they can save on out-of-pocket expenses of which deductibles, co-insurance and co-payments are the most common.

Deductibles, co-insurance and co-payments are in fact on the increase. All FEHB fee-for-service (FFS) plans – whether they are PPO or not – have over the years raised their average deductibles.  Federal employees and retirees should focus on both plan premium increases and out-of-pocket increases before choosing a health insurance plan.

One of the best ways to pay for increasing out-of-pocket health, dental and vision expenses is through a health savings account (HSA) which is discussed in this column.

What is a Health Savings Account?

HSAs are in simple terms tax-favored accounts that allow HSA owners to save for any type of prescribed or necessary medical care that is not covered by their insurance plans. This includes health, dental and vision care. HSAs have exploded in popularity over the past 10 years. According to the consulting firm Devenir Group, total HSA assets have risen from $1.7 billion in 2006 to $37 billion in 2016. The firm says that HSA assets are projected to increase to $53 billion in early 2018.

There are specific requirements that an individual must fulfill in order to participate in an HSA, the most important of which is that the individual must be enrolled in a high deductible health plan (HDHP). The individual cannot be enrolled in a health maintenance organization (HMO), TriCare (group health insurance covering members and retirees of the uniformed services), or any part of Medicare (Parts A, B, C or D). Nor can an individual have secondary coverage in any of these plans to their primary coverage under a HDHP.

Each year, the IRS defines what the minimum deductible is for a health plan to be considered a high deductible health plan. For 2018, the minimum deductible for a self only HDHP plan is $1,350, while for a self plus one or self and family HDHP plan the minimum deductible is $2,700.

While some federal employees and annuitants may consider these minimum deductibles rather high, they should also consider what their current deductible is in their non-HDHP plans during 2017 and what these deductibles will be in 2018. Many FEHB plans offering self only coverage have deductibles averaging in the range of $500 to $1,000, while self and family FEHB plans have deductibles averaging $1,500 to $2,000. In short, non-HDHP  PPO FEHB plans have deductibles approaching the $1,350 and $2,700 minimum deductibles for HDHPs.

Triple Tax Savings With HSAs

It is also important to emphasize the triple tax savings associated with HSAs. First, contributing to a HSA results in a federal tax deduction. In particular, contributions made by the HSA owner are an “adjustment to income”, reducing the owner’s adjusted gross income (AGI). Unlike contributions to a deductible traditional IRA in which there are AGI limitations, there are no AGI limitations for contributing to an HSA. Second, HSA accrue earnings which grow at least tax-deferred and are tax-free when withdrawn to pay for qualifying medical expenses. All withdrawals from a HSA are tax-free if the withdrawals are used to pay qualifying medical expenses. These expenses include out-of-pocket expenses for health, dental, vision are and long term care expenses including long term care insurance premiums. They also include Medicare Part B monthly premiums. In that sense, qualified HSA withdrawals are identical to the Roth IRA withdrawals which are tax-free.

Health Savings Accounts are therefore very good savings vehicles like IRAs. Those employees and annuitants who can afford to pay their present medical expenses out of their current cash flow rather than through HSA withdrawals can benefit more from the tax-free long term savings associated with HSAs. Unlike traditional IRAs, there are no minimum distribution requirements and no requirements to begin withdrawals of HSAs at a certain age.

HSA Limits and Limitations

There are several limits and limitations that potential HSA owners need to keep in mind. As previously mentioned, employees and annuitants who want to contribute to an HSA during 2018 must be covered by an HDHP. They cannot be covered by any secondary health coverage either through their own enrollment or through a spouse. They cannot be enrolled in any part of Medicare or TriCare.

The maximum allowable contribution during 2018 is $3,450 for self only coverage and $6,900 for self plus one and self and family coverage. Each paydate or month an employee or annuitant who is enrolled in a FEHB-sponsored HDHP will have a portion of their FEHB premiums automatically deposited into the employee’s or annuitant’s HSA. This is called the “premium pass-through”. Employees and annuitants who enroll in one of the HDHP’s offered through the FEHB program can find out what their “premium pass-through” is by going to www.opm.gov/healthcare-insurance/healthcare/health-savings-accounts/hdhp_benefits-hsanetamounts.pdf. OPM also has an HSA worksheet that allows employees and annuitants can determine if enrolling in a HDHP makes financial sense for them . The worksheet can be found at:  www.opm.gov/healthcare-insurance/healthcare/health-savings-accounts/worksheet.

Those employees and annuitant age 55 and older during 2018 can contribute an additional $1,000 “catch-up” contribution to their HSAs during 2018. They actually have until April 15, 2019 to make their contribution for 2018.

Withdrawals from a HSA and not used to pay qualified medical, dental or vision expenses are subject to federal and state income taxes and a 20 percent early withdrawal penalty. HSA owners over age 65 who withdraw from their HSAs but do not use the withdrawals to pay for qualified expenses are subject to federal and state income taxes but no 20 percent penalty.

Before employees and annuitants decide on enrolling in an HSA associated with a HDHP, they should consider other health insurance options offered though the FEHB. If an employee or an annuitant ends up paying more in out-of-pocket medical expenses while covered by an HDHP then they would have paid with a lower deductible plan, then they may want to consider the lower deductible plan. Those additional payments may leave the employee or annuitant in a worse financial position. In short, HSAs do not make sense for families who need frequent and/or specialized care. HSAs are best suited for those employees and annuitants who are healthy, do not visit the doctor often, and want to save for paying for future medical expenses in a tax-advantaged way. An HDHP  may be ideally suited for those employees who are relatively new to federal service or in mid-career who are in good health and want to save for expenses they will likely incur during their retirement years. Among the expenses they can pay or get reimbursed for by using HSA withdrawals are long term care insurance premiums.

Employees and annuitants who enroll in HSAs will be assigned an HSA custodian. They have the option of using another HSA custodian who could invest the HSA funds in a more aggressive way. Much like the traditional and Roth IRA market, fees vary from one HSA custodian to another, as do investment options. Employees and annuitants are therefore encouraged to carefully check on an HSA’s recurring fees and investment options before deciding on an HSA custodian.