Should you use a High-Deductible Health Plan to Save for Retirement?

When you think of a health insurance plan, high-deductible health policies might not be your first preference. Typically, this is because of their restrictive coverage that usually falls significantly short to cover the overwhelmingly increasing medical costs. While in comparison, a health insurance plan is generally more effective with a lower deductible, leaving you to pay less in medical costs. Even though this makes health insurance plans a preferred choice, it may not be ideal for everyone, especially those planning for retirement.

For retirement planners, a high-deductible health policy (HDHP) can make for a good choice. In some parameters, an HDHP offers more benefits that overcome its disadvantages. The most critical advantage being long-term financial growth, which significantly helps to boost your retirement corpus.

Here is all the information you need to decide if a high-deductible health plan is good for your retirement:

What is a high-deductible health plan?

A deductible is defined as the amount you pay out of your pocket for medical expenses before the insurance plan starts to offer any benefits. A high-deductible health plan is like an affordable health insurance plan. However, as the name suggests, an HDHP has higher deductibles as compared to a traditional health insurance policy. So, you would pay a substantial annual deductible before the insurance policy reimburses any of your health costs.

According to the Internal Revenue Service (IRS), an insurance policy with a deductible of $1,400 and $2,800 or more for individuals and families, respectively, is termed as a high-deductible health insurance plan. In addition to this, for 2020, the total out-of-pocket expenses should not be higher than $6,900 and $13,800 for an individual and family plan, respectively. That said, for 2021, HDHP’s maximum out-of-pocket expenses are $7,000 and $14,000 for individuals and families, each.

Who offers high-deductible health plans?

Many employers offer high-deductible health plans to their employees to reduce the insurance costs for both employers and employees while still providing considerable coverage. Most often, HDHPs require you to cover medical expenses from your pocket until you reach the deductible amount. In most cases, HDHPs are economical as compared to traditional health insurance policies.

Further, to enable employees to cover their annual deductible limit, employers also permit employees to set up a health savings plan (HSA). An HSA is a tax-advantaged savings account that is designed specifically to help those that have an HDHP. An HSA offers triple tax benefits, similar to an IRA (Individual Retirement Account) or a 401(k) account, consisting of tax-free-contributions, tax-free growth, and tax-free withdrawals. However, if you tap into an HSA for non-medical expenses, you could trigger a 20% penalty, in addition to the income tax charge.

An HSA can be a highly beneficial retirement investment if you begin investing in it early in life. You can make tax-deductible contributions in an HSA every year. Each year the IRS announces new upper limits for HSA contributions. For 2020, you can contribute up to $3,550 for self and $7,100 for family. For 2021, you can contribute up to $3,600 for self (up by $50 from 2020), and up to $7,200 (up by $100 from 2020) for family.

What are the pros and cons of an HDHP?

To evaluate if you should use a high-deductible health plan to save for retirement, understand the pros and cons of an HDHP.

Pros

The best advantage of an HDHP is that it offers lower premiums in comparison to a traditional health insurance policy. Hence, if you are single with no medical conditions, you can safely consider an HDHP to save some dollars. An HDHP is undoubtedly one of the most economical types of health insurance plans. However, if you opt for an HDHP, it is advisable for you to keep some liquid savings to cover your deductible, as well as any immediate or emergency medical expenses.

That said, besides lower premiums, with an HDHP, you also get access to make contributions to an HSA, which offers a triple-tax advantage for retirement savings. As HSAs involve pre-tax dollar investments, you can considerably save more on your medical expenses when you pay via this account. Apart from the other tax-advantages, such as tax-free growth and withdrawals, an HSA also allows you to take advantage of optional catch-up contributions made by employers, which is typically ‘free money’. In addition, it is not mandatory to hold your HDHP account to use your HSA. In the future, even if you do not own an HDHP, you can still use the funds deposited in your HSA to cover your medical expenses.

Cons

The biggest drawback of an HDHP is the high-deductible amount, which implies you have more out-of-pocket expenses in a year. Besides, if you anticipate high medical costs in the coming year or have a family, you can consider a health insurance plan that might charge you higher premiums but will also give you coverage for out-of-pocket expenses. Owning an HDHP with high medical costs is more likely a problem than an investment. Every dollar you save in the short-term by avoiding visits to the doctor will cost you more eventually in the long-term when the problem intensifies. According to a survey conducted by the Kaiser Family Foundation in June 2019, half of the participants delayed or missed medical care (including dental care) because they could not afford the costs.

Is an HDHP the right choice for you?

The ultimate decision of opting for an HDHP depends on your life stage and the medical expenses you are likely to incur. If you are young and healthy and expect minimum medical costs, it is beneficial to choose an HDHP over a traditional insurance policy. However, if you have a health condition, are planning to have a baby in the future, or have young children, an HDHP, even with the lower premiums, might not be the best choice. Moreover, if you are older, you are more likely to need an extensive cover, unlike an HDHP.

Alternatively, if you can consider investing in HDHP linked HSA for the long-term, an HDHP might be a great option irrespective of your age, family status, and health conditions. You can take advantage of the HSA triple-tax benefits to the maximum possible limit considering the time horizon marginal tax rate, and investment returns. Consider this example:

Suppose you fall into the 25% federal tax bracket and contribute $3,600 to your HSA. You are 15 years away from retirement and, hence, you hold the HSA 2021 contribution (of $3,600) up until retirement. This present contribution is nearly $1,100 higher than a relative retirement plan contribution, as per the current dollar value. When you compare this with a traditional insurance plan, the tax-benefits of the HDHP with an HSA will stand out.

To sum it up

Overall, the decision of whether you should use a high-deductible health plan to save for retirement depends on your individual and family health care needs. Informed choices set a strong base for the future. So, if you are unsure of which option to go for, you can always consult a professional financial Aadvisor to determine the healthcare policy that suits you the best.