EDITOR'S NOTE: This article was originally published in the April 2011 issue of Kiplinger's Retirement Report. To subscribe, click here.
If you need health insurance before Medicare begins, take a look at a high-deductible plan coupled with a health savings account. The combination can cut federal taxes now as you stash away money you can use tax-free for medical expenses in retirement.
To qualify for the tax break, the policy must have a deductible of at least $1,200 for self-only coverage or $2,400 for family coverage. The policy also must limit out-of-pocket costs to $5,950 for self-only ($11,900 for a family plan). Once you enroll, you can open a health savings account and contribute up to $4,050 if you're 55 and older (or $7,150 for a family).
The tax breaks are big. If your employer offers a high-deductible insurance plan, you can make pretax contributions to the HSA. If you buy an individual policy, you can deduct contributions to the account. Withdrawals to pay for medical expenses are tax-free.
Despite the high deductible, these plans, coupled with the tax savings, may well end up being cheaper than a non-HSA plan. With many HSA-compatible plans, once you satisfy the deductible, there are no co-payments for hospital and doctor visits. "It's rare that anyone is worse off switching to an HSA," says J. Kevin McKechnie, director of the American Bankers Association's HSA Council. With an employer contribution to an HSA and the tax breaks, says McKechnie, "it's a no-brainer."
The number of HSA-eligible plans is growing like gangbusters. About ten million individuals were enrolled in HSA-compatible insurance plans in January 2011, up 25% from a year earlier, according to American Health Insurance Plans. About 29% of participants were 50 and older.
If you're looking for an individual policy, you can compare HSA and non-HSA plans at www.ehealthinsurance.com. You will need to assess the premiums, co-payments, drug benefits and limits on out-of-pocket costs for each plan. Some plans count co-payments for drugs toward the deductible, while others don't, for example. "Make sure the doctors you plan to see are covered by the plan," says Roy Ramthun, president of HSA Consulting Services, in Silver Spring, Md.
Also figure in the potential tax savings. If you're in the 25% tax bracket and socking away $4,000 in an HSA, you'll cut $1,000 from your income-tax bill -- a good chunk of a plan's deductible.
Paying for Health Expenses in Retirement
Older individuals should consider investing their HSA to build a tax-free kitty for health costs during retirement, says William Applegate, vice-president of HSA business development for Fidelity Investments. You can set aside part of your HSA in cash to pay for immediate medical expenses and invest the rest to grow, but in nothing too risky. "You should invest HSA funds the same way you invest your retirement funds," he says. Unused money can roll over from year to year.
Fidelity offers this scenario. A 55-year-old couple contributes the maximum $7,150 each year (adjusted for inflation) for ten years in a portfolio of 50% stocks and 50% bonds and cash. Assuming average market conditions, they'll have $93,000 by age 65 in tax-free money to pay for medical expenses.
Most large banks and many community banks offer federally insured HSA checking and savings accounts. Your choices are narrower if you want to invest in mutual funds, stocks and bonds. Two options: With a Fidelity HSA, you can invest in Fidelity mutual funds, stocks and bonds, or at HSABank.com, you can invest through a TD Ameritrade brokerage account. Some banks offer a limited choice of mutual funds.
James Gandolfo, a senior vice-president for Bancorp Bank, says you should compare HSA banks as you would financial institutions that you use for your regular banking needs. "You're looking at interest rates, fees and ease of use," he says.
Like many bank HSAs, the Bancorp Bank HSA offers a checking account and a debit card to pay medical bills. You can also pay medical bills online, and your account will accept direct deposits by payroll deduction.