Putting aside money for emergencies, like replacing a roof or a major car repair, is one of the age-old mantras of personal finance.
But today there’s one major potential expense that, until relatively recently, few working people rarely thought about: Paying for out-of-pocket medical costs.
Why? Because until the past decade or so, most employer health care plans covered the majority of employees’ medical costs.
The spiraling cost of health care has resulted in many employers shifting more of these expenses to employees. Monthly premiums for traditional health care plans that used to be fairly reasonable now may cost $600 per month or more. And most of these plans have annual deductibles — money you must pay out of pocket for medical expenses before the plan takes over most of the costs.
Since most employees can’t afford these plans, many companies now also offer high-deductible health plans (HDHPs). How pervasive are these plans? In 2019 51% of all U.S. employees were enrolled in HDHPs.
And for those who aren’t covered at work and have to purchase their own health insurance, HDHPs generally offer the lowest premiums of plans available in state and Affordable Care Act insurance marketplaces.
However, someday — maybe a few years from now, maybe next week — you will need medical treatment for an injury or a major illness. If you’re not financially prepared, you may discover the hard way what “high-deductible” really means.
Three kinds of expenses
Your HDHP may state that it has a $4,000 annual deductible. That means you’ll have to use $4,000 of your own money to pay for medical treatments before the plan starts covering some of the costs. If you don’t believe you’ll have to pay that much, think again. In 2018, the average cost for a knee replacement was $35,000. For spinal fusion, $110,000. Thinking of having a child? It could cost you $4,500 or more once all pre-natal care, delivery and post-partum expenses are tabulated.
As a participant in an HDHP, I’ve personally experienced the painful price of health care. Last year I was healthy for most of the year, but the costs for one visit to an out-of-state emergency room and follow-up appointments ate up my entire $2,800 deductible.
Thankfully, my deductible was relatively reasonable, considering that in 2020 the average deductible for individual subscribers was $4,364 and $8,439 for those with family coverage, according to research conducted by eHealth.
But your expenses may not end when you hit your deductible limit. Many HDHPs require to you to continue to pay partial costs through co-payments and co-insurance.
Co-payments are fixed amounts you pay out of pocket for health care expenses. How much you pay depends on whether you’ve hit the deductible or not. For example, if a procedure costs $500 and your co-payment for such a procedure is $20, you'll pay $20 only if you’ve paid the maximum deductible. Otherwise, you’ll pay the full $500 out of pocket.
If deductibles and co-pays weren’t enough, co-insurance can add even more to your medical tab. It’s a percentage of covered health care services you may still have to pay on your own even when you’ve maxed out your deductible.
Let’s say your plan has a 25% co-insurance requirement. If you’ve already hit your deductible and then have another procedure that costs $1,000, you’ll still have to pay $250 out of pocket.
When does it end?
Fortunately, the IRS sets maximum annual limits for total out-of-pocket medical expenses for HDHPs. In 2022, this limit is $7,050 for individuals and $14,100 for families. Any expenses above that level will be fully covered by your HDHP.
But remember — these limits reset every plan year.
Health Savings Accounts to the rescue
If there’s one silver lining in this scenario, it’s that many employers that offer HDHPs also offer Health Savings Accounts (HSAs).
With an HSA, you make pre-tax contributions from your paycheck to an investment account that allows you to withdraw contributions and earnings tax-free to pay for qualified health care expenses.
In addition to medical treatments, you can use your HSA to pay for prescription and over-the-counter drugs, medical equipment, dental expenses, physical therapy and even acupuncture and aromatherapy. You can also use your HSA to help pay for long-term-care insurance premiums.
For 2022, the maximum amount you can contribute is $3,650 per individual ($7,300 per family) with an additional $1,000 in “catch-up” contributions per person for those 55 and older. Some employers also make periodic contributions to their employees’ HSAs to help offset some of these out-of-pocket expenses.
The great thing about HSAs is that you never have to make withdrawals. For example, you may choose to pay your current medical bills from your savings and reserve your HSA money for health care costs during retirement. (Note that once you enroll in Medicare you can no longer contribute to an HSA.)
If you start a new job with an employer that has an HDHP and HSA, you can transfer the assets from your old HSA into the new HSA. If they don’t offer an HSA, you can move assets from your old HSA into one offered by a financial services company. Keep in mind that if you don’t enroll in your new employer’s HDHP (or they don’t have one) you can’t make additional contributions to your HSA.
Having an HSA can help take the sting out of out-of-pocket medical expenses when they occur — but only if you contribute to it.
This may be challenging if you’re also trying to save for retirement, your children’s higher education or a new home. But considering that the pre-tax contributions you make to your HSA have the same taxable-income-lowering benefits as contributing on a 401(k) account, there are advantages to contributing as much as you can to both accounts.
If you’re fortunate enough to receive a tax refund, consider contributing some of it to your HSA. Even though these contributions are after-tax, they may be deductible. If you’re planning on doing this, make sure that your combined pre-tax and after-tax contributions don’t exceed the annual limit.
Other ways to lower health care expenses
This may sound like a tough-love situation, but the fewer family members covered by your plan the lower your premiums and out-of-pocket expenses may be. If your adult children are covered by your HDHP but work for a company that offers its own health care plan, it might be time to encourage them to experience the “joys” of managing their own health care expenses. They’ll have to do it anyway, since at some point they’ll be too old to be covered by your plan (generally age 26, but higher in a few states).
If you and your spouse both have HDHPs at work, compare the monthly premiums, deductibles, co-pays, co-insurance and maximum out-of-pocket expenses for each option. If both options let your use your current primary care physicians and specialists, you may both want to switch to the more potentially affordable option.
And if you’re thinking of having a procedure done, you may also want to estimate total costs in your area.
It’s unfortunate that people may need to add “future health care costs” to their list of savings goals, but this is a reality that many will have to plan for. If you need help figuring out how to balance these competing priorities, a qualified financial planner can provide guidance to help you make sure that staying healthy doesn’t significantly harm your financial well-being.
Joelle Spear, CFP® is a financial adviser and a partner at Canby Financial Advisors in Framingham, Mass. She has an MBA with a finance concentration from Bentley University.
Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser.
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