As I mentioned in my recent post, I’m currently looking into what health insurance to select for next year. I have the options of Anthem HDHP, Anthem PPO, Anthem HMO and Kaiser HMO.

Typically, as a healthy-ish young adult, I’d select the HDHP. I’ve always been a proponent of HSAs, but now I’m not so sure – especially living in California, one of the two states in the country that doesn’t recognize HSAs as pre-tax income. It’s actually a rather complicated tax situation in CA that no one explains well… and I’m unsure if even I’ve been filing my taxes right with my HSA all these years!

What is an HSA?

An HSA is a supposedly tax-free account for healthcare costs. If you have an eligible health plan, you can contribute up to a certain amount per year (~$6900 for a family next year) which is put into the account pre-tax* and then you can invest that money and whatever it grows to you can take out tax free if used for qualified medical expenses at any point in your life. It sounds like a really good deal… and it is… except HDHPs have “high deductibles” and, even more troubling, HSA plans typically have very high fees that eat into any growth you see unless you are a wise investor (AND have access to good investing options, rare in typical employer-sponsored HSA accounts.)

*HSA Rules in California

What makes matters worse, California (and New Jersey) doesn’t recognize the HSA at all. So, any money you put into it is taxed as income. That seems to be handled automatically via the W2, since the employer makes those contributions on your behalf. But then you also (and I didn’t actually know this until yesterday) are supposed to pay taxes on dividends and any interest earned in the account annually. My HSA account is relatively small (it’s now about $7000) BUT I have to go back and amend returns likely if I have any earnings on the account each year. I did actually merge two accounts which, since both accounts did not have the same funds, required selling all of my funds to roll them into the other account last year. I’m guessing that will hit my 2017 taxes — and I’m not clear yet if gains will be taxed as long term capital gains or income. Not one HR person has explained this or mentioned this in all my years working… probably because they aren’t allowed to give tax advice… but it seems like something they should mention.

“Depending on what kind of annual statement the financial institution sends out, it could be extremely difficult to figure out how much HSA income account holders should report on their California tax return each year.” – SF Chronicle

Yup. I don’t recall ever getting annual notices regarding my HSA account’s tax information. The good news is that now that I’ve transferred all of my old funds to HSA Bank, I at least will have my records in one place – for this year. Well, sort of. I have two months worth of HSA funds at my new employer – though I’ve heard they’re actually using HSA bank now and transferring to a new system. I should probably check on that, since I have no idea where my new HSA funds are at the moment. Next year it will be a different bank that apparently provides fewer investment options in “funds.” This may still be worth it for the federal tax savings (over many years, as a retirement health account) BUT it’s troublesome that California is refusing to provide the tax treatment that the rest of the country (except NJ) offers. This state really is an expensive place to live.

HSA Account Math, Family of 2 (Example)

Family Out of Pocket Max: $9000
Monthly Cost (Annualized): $1030(*with employer coverage and contribution)

Max Out of Pocket Family of 2: ~$10k

HSA contribution: $6900
HSA contribution, 3% growth, in 30 years: $16,748

Value of tax deduction, federal: $2415 (35% bracket)
Value of tax deduction, state: $0 (or, -$897)

So, you pay $897 (state tax) + $5650 investment + $10k today = $16547 to have $16,748 in 30 years (*WITHOUT FEES ADDED)

(someone please check my math.)

Now, that doesn’t really work either – because unless you’re invested in TIPS (treasury funds that are tax advantaged), you’ll be taxed on any dividends earned by that investment every year, like it was a taxable account, for state purposes only. That will cut into your growth a bit.

Then, you also have to pay HSA bank fees, which are very high and also cut into your “savings.” Example fees include:

• Maintenance fee and Service Fee:  $66 per year (if your bank account balance / non-invested funds – is under $5000)
• Monthly Investment: $21.00
• Using your HSA Card: $2 per transaction (!)
• Access Funds Through Internet Withdrawal: $2 per transaction

In any case, I’m not sure I know enough to call the HSA a sham, but it sure looks like a way for the bank to charge a lot of fees. And, just like any other screwed up government-created account (screwed up due to people in government not agreeing on anything and not giving a shit about the people of this country), the HSA which is supposed to be this brilliant tax free way to save for future healthcare needs is ACTUALLY just a way for banks to make money off of people who likely don’t even realize it.

It’s pretty crazy that there is a $2 fee to even use funds in the account EACH TIME YOU TRANSFER FUNDS OR USE YOUR CARD. This administrative fee might be necessary to cover the cost of running an HSA account, but if that’s the case, is it even worth it?

Now – if you can invest the funds in the market and do better than 3% a year, it gets a little more interesting. Still, because you’re investing in the market, what goes up can come down. As a long term investment it’s probably safe – which is why young people are wise to consider HDHPs and HSAs. However, none of this is discussed in open enrollment meetings. AND, most people consider an HSA just a larger FSA, and put their money in the account pre-tax and then spend their funds down over the course of the year. While there’s nothing wrong with this, per se, you are now paying $2 per doctor’s appointment to use your card. If you go to the doctor a lot, let’s say 20 times a year per family, you just spent $40 on going to the doctor in fees. For someone in a lower tax bracket who isn’t seeing that much in tax savings via a HDHP (since you only save the money from your top tax bracket), it may actually be a scam.

Let’s not forget that in the event of death, your HSA is taxable to your heirs entirely as income at their income tax bracket. While it can be used to pay off qualified medical expenses of the person who died and owned the account,  anything left over is taxed as income. However, after 65 an HSA account owner can take out funds for non medical expenses without a 20% penalty. BUT, those funds will be taxed as income, just like a 401k.

So as much as I’m tempted to go the HDHP route next year (assuming we’ll spend the full $9000 out of pocket max) just to get those $6900 in federal funds in to an HSA pre tax, I’m really not sure it’s worth it.

PPO Costs in Comparison…

Family Out of Pocket Max: $5k
Monthly Cost (Annualized): $3k

FSA contribution (*is recognized as pre-tax in CA) = $2650 ($1272 tax savings)

Total Costs including FSA savings: $6728

PPO vs HDHP Costs Today

PPO: $6728 ($9819 remains to invest in post-tax accounts)
HDHP: $16547 (*includes $6900 investment)

PPO vs HDHP investments in 30 years (at 3% interest) – WITHOUT FEES ADDED

PPO: $23,883
HDHP: $16,748

IF USED FOR QUALIFYING MEDICAL EXPENSES (TAXED OR NOT TAXED)

PPO: $19945 ($3937 in cap gains tax, CA)
HDHP: $16,748 (minus fees and state taxes – which could be significant over the years)

So, if my math is correct there, the PPO actually ends up being the BEST plan long term anyway, with taxable investments, at least in the state of CA (and probably in other states, although it might look a little better without state tax.

What About if I Don’t Hit My Out of Pocket Max?

Ok, so for arguments sake, let’s look at a more typical HSA scenario. You’re a healthy 20 something with 40 years until retirement. As a single person you can put $3450 into your HSA. You’re smart, so you plan to invest this month over the next 40 years vs spending it from this account. You have a HDHP and your annual out of pocket plan cost is $840. Your employer contributes some money, let’s say $1000, so you’re already ahead, paying -$140 (*minus CA state tax, I’ll get to that in a bit) — so your annual costs are negative, before you start using your account.

You scrounge up the funds to put in the $2400 ($200 per month) into your account this year, which will be augmented by the employer’s contribution up to your max of $3400.

You don’t get sick often, so you don’t hit your medical deductible or out of pocket max. Let’s say you spend $1000 on a few office visits and blood tests due to a scare, but nothing major – no ER visits, no recurring specialist visits. So, now your total cost of healthcare this year is $2400 and you’re getting a federal tax savings on your $2400  investment (but paying state income tax on this.)

Your federal tax savings, since you’re in a lower tax bracket (in your 20s, we assume) is 15% (if you make up to ~$38k.) So your tax savings on this is $360 (if you make $38k-$93k, you’d save $600.) You still have to pay state tax on this income – let’s say that’s $3400*8%=$272 for the sake of simplicity.

So, adding up all the numbers with HDHP, $1000 medical spend and $3400 annual investment as per the rules above

Healthcare cost = -$140 (annual premium) + $1000 (medical expenses) + $2400 (investment) + $272 state tax – $360 tax savings = $3172

In 30 years (to compare to other couple above) you have:

HDP: $8252 – $3172 initial cost = $5080 (gained, as long as it’s used for healthcare)

Now, let’s say this same person used a standard PPO.

The math is tricky because we don’t know how the deductible and coinsurance will play out, but let’s say they have a $250 deductible but a higher monthly fee.  It’s a $1080 fee for the year, but with the lower deductible instead of $1000 in healthcare spending, it’s more like $350 due to the low deductible and co-insurance.

Annual healthcare spend = $1430

But we’re not done yet…

Since this person didn’t spend $3172 on healthcare this year (including the $3400 investment), they have $1742 left to invest in taxable accounts.

With the PPO, they have $4228 in 30 years at 3% growth ($2486 taxable at investment gains rates) = 2486-696 = $1789
With the HDHP, they have $5080 (gains) in 30 years at 3% growth

In this case, the HDHP appears to win (significantly.) Even if they take out the HDHP money for non healthcare use and pay the 20% fee in 30 years and income tax on this amount (Let’s say 25% income tax plus 13% state) = $2387.60  you are still ahead of the $1789 if you invested in a taxable account.

This isn’t taking into account HSA fees over the years, which add up and might make both worth a similar amount. AND you’re taking on the risk in the HDHP that you won’t need to use the full out of pocket max ($4500) which clearly makes the math reverse. Very quickly.

So IMO HDHPs and HSAs are only good for young, healthy individuals who have a low chance of needing to use their health insurance each year beyond a few routine doctors visits. Otherwise, I’m not sure they offer better savings than a lower deductible account and saving that money to put into the market. What isn’t covered here is that your investment options will be much broader in a non HSA account, and fees will be much lower (or at least you can choose if you want a higher fee account.)

Is all of that worth ~$600 in gains (per year) — which is probably more like $450 per year after fees? This is if you don’t use your actual health insurance much… one trip to the emergency room and your numbers suddenly won’t look so good.

This is why I’m leaning towards thinking the HSA is a scam for everyone. It’s too risky for the minimal reward you get for investing in it vs a PPO and investing any remaining funds in a taxable account.

Does anyone disagree?