Here’s a nuts-and-bolts plan for protecting your savings from high health-care costs.
6 min read
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The cost of health-care related expenses, from insurance to prescription drugs to out-of-pocket copays, is out of control and can eat up our wealth as fast as we make it. Fortunately, there are some things we can do to prepare and insure ourselves against catastrophic health-care costs during our lives. Following are three bedrock strategies to writing off all your health care.
Health Savings Account (HSA)
The Health Savings Account is one of the most powerful pieces of a well-designed health-care strategy. It includes saving money, saving taxes, building a tax-free bucket for health care, and, most importantly, taking control of your own health-care strategy. You save money because in order to have an HSA, you have to have a high-deductible health-care plan (which usually means you’ll have a lower premium with a higher deductible and be able to save money).
Also, you save taxes because you get a tax deduction when contributing to your HSA. At the same time, you build a tax-free bucket of money in an HSA, just like an IRA. The money can be invested, the growth is tax-free, and withdrawals for health care are also tax-free.
Finally, you take control of many health-care decisions because you can pay cash out of your has and there’s no insurance company between you and your health-care provider where you can control your care and negotiate for lower prices. Now, let’s hit the nuts and bolts:
1. The Tax Deduction. Your HSA contributions are deductible from your gross pay, or business income. This gives you a tax deduction and can potentially put you into a lower tax bracket. The tax deduction has been hovering between $3,000 to $4,000 for singles and $6,000 to $7,000 for families, adjusted for inflation each year.
2. Tax-Free Growth. The funds grow tax-free and aren’t a “use it or lose it” plan. The HSA account grows and builds for your future health-care needs. Investments aren’t counted towards contributions either.
3. Tax-Free Withdrawals. You can spend the money tax-free on qualified medical expenses, including deductibles, dental, eye care, chiropractic care, acupuncture, and even hotel and lodging while at the hospital. Moreover, you can start taking out money immediately—there’s no waiting period.
4. Self-Direct Your HSA Investments. You aren’t simply stuck with a mutual fund option provided by your bank. You could invest in a restaurant, real estate, or even Super Bowl tickets. If you want to self-direct, just place your HSA funds with a custodian that allows for self-directing rather than with your local bank.
5. Help Pay for Your Retirement. After you turn 59 1/2, you can withdraw the money for non-health-care expenses, then pay federal income taxes on it. The HSA then acts like a traditional IRA since the HSA holder pays ordinary income taxes on nonmedical-related withdrawals, with the added perk that you don’t have the mandatory disbursements usually required by traditional IRAs. This protects you from the concern I often hear, “What happens if I don’t need the money for health care?” The simple answer is, don’t worry—you can use it like an IRA in the future.
Health Reimbursement Arrangement (HRA)
If you have more than $5,000 a year in out-of-pocket medical expenses, chances are, you could benefit from an HRA. In fact, legislation that went into effect for small-business owners in 2017 allows you to write off up to $10,000 of medical expenses before insurance premiums and off the top (not like itemized medical expenses).
Chances are, you aren’t getting any sort of a tax deduction for these extra medical expenses, and just imagine if you could deduct 100 percent of these medical costs. Even further, imagine the power of this strategy if you have significant medical costs in your family and you could deduct $10,000 or $20,000 of medical costs—it could be life-changing!!
What are the rules?
- An HRA can only be used by small-business owners. It’s an employee benefit to reimburse the medical costs of the employee, which could be you!
- If you’re single, you’ll need to utilize a C Corporation to employ you with a W-2 and provide the HRA.
- If you’re married, you can probably implement an HRA simply through the use of a Sole Proprietorship, keeping the cost down.
- For those of you already utilizing an S Corporation, you’ll need to use the C Corporation or Sole Proprietorship described above.
- You’ll need to implement an HRA plan document and procedure for reimbursement, which can actually be affordable, self-administered, and simple to do.
In summary, you must have a profitable small business to implement the HRA, you should have medical expenses of at least $4,000 a year to justify the additional administrative cost of the structure, and you should get some professional advice regarding your situation. The HRA isn’t particularly expensive or difficult to implement, but it’s something the average person shouldn’t try to figure out on their own. Get some guidance if you think the HRA is a potential strategy for you.
401(h)—The Trifecta of Retirement and Health-Care Planning Benefits
The 401(h) is similar to the 401(k) but different in some significant ways. Not only do you get a tax deduction upfront, followed by tax-deferred growth on your investment, but you can withdraw 100 percent of your money tax-free as long as you spend those withdrawals for medical purposes.
The 401(h) is an add-on to a defined benefit plan and allows you to contribute a significant amount of money annually to ultimately create a pool of money to access at retirement for health-care and even long-term care costs. How much you can contribute is based on your age, income, and the ages and incomes of all the other employees in the organization. The contributions can range from somewhere around $25,000 to $50,000 a year, which is significantly more than the amount of money you could contribute to a traditional HSA-type plan.