Health Insurance and Using Your HSA as a Stealth Retirement Account

I’ve written a bit about health insurance before, going through the options for Littleton Public Schools (LPS) and Douglas County School District (DCSD). I was recently helping someone and thought I would update the numbers given LPS’s current insurance offerings, and also spend a bit more time talking about possibly using your HSA as an additional “stealth” retirement account.

First, a caveat: Health insurance is complicated and differences in individual circumstances as well as specific scenarios will vary. These are some “generic” examples that give you an idea of ways you can compare plans, but will not cover every circumstance.

LPS currently offers four choices for health insurance: CIGNA OAP, CIGNA CDHP, Kaiser DHMO, and Kaiser HDHP. The CIGNA CDHP and Kaiser HDHP both qualify as high-deductible plans, so you are eligible for an HSA, and the district contributes $1,250 a year into your HSA for employee only coverage, or $1,700 a year for any dependent care coverage. The following table summarizes the yearly premiums for each plan as well as the deductibles, coinsurance and maximum out-of-pocket expenses you could have.

The table below allows you to compare CIGNA OAP with CIGNA CDHP with HSA, and then Kaiser DHMO with Kaiser HDHP with HSA (and, of course, then CIGNA to Kaiser). The examples I chose for illustrative purposes are $2,000 a year in charges if you have individual coverage and $4,000 if you are covering any dependents. The total out of pocket listed in the tables is comprised of the total you pay in premiums, plus any out of pocket costs, minus the district contribution to your HSA if you choose one of the HDHP plans ($1,250/year for individual, $1,700 for any dependent coverage).

Note that these are rough estimates – for simplicity’s sake it just assumes you pay the 20% coinsurance after the deductible – but that totally depends on what services you need, so your exact total could differ (but it should be a pretty good estimate for comparison’s sake). You can do the math (or contact me and I’m happy to help) for amounts different from the $2,000/$4,000 examples. Also keep in mind that if you have expensive prescription drugs, that could change the calculations (because you typically pay for those out of your deductible in HDHP plans). Finally, keep in mind that you may – or may not – be having health care premiums taken out pre-tax (and pre-PERA), so that can impact your overall totals as well (but they are still directionally accurate).

In general, there are very few scenarios where the high deductible plans are going to cost you more (mostly involving expensive specialty prescription drugs). And even if in one given year it costs you more, you’ll likely more than make up for it in the “normal” or even “good” years where you spend less. Another important consideration to keep in mind with the HDHP plans is that if you don’t spend what is in your HSA (either contributed by the district or additional pre-tax dollars contributed by you), that money rolls over for future years (so you have the potential of $1,250/$1,700 from the district plus your own contributions to the HSA to rollover each year, plus any investment gains over time). So in years where you have lower expenses, the savings from an HDHP plan are even greater than shown above (because your premium costs are the same no matter how much care you get, but your out-of-pocket costs vary with how much you use the plan).

As you can see, for these examples ($2,000/$4,000 in costs), the high-deductible plans come out much better and, not surprisingly, Kaiser comes out better than CIGNA. (And, in years where you spend much less than $2,000/$4,000, the high deductible plans will come out even better.) In general, the only reason to go with CIGNA over Kaiser is if you already have an established relationship with a doctor with CIGNA and don’t want to lose that relationship. And there’s very few circumstances where it makes sense to go with the OAP or DHMO over the high-deductible plans.

If you do go with a high-deductible plan, then there’s a strategy to really supercharge your HSA. HSAs are designed to help you pay for health care costs with pre-tax dollars (not just pre-federal and state, but pre-FICA as well, but not pre-PERA). Similar to an FSA, they allow you to reimburse yourself for health care costs out of your HSA. Unlike an FSA, however, the entire balance in your HSA can rollover from year to year if you don’t spend it, the total amount you can contribute each year is higher, and you can invest the money in your HSA if you choose (typically there is a minimum threshold you have to keep in cash, but then you can invest any amounts above that).

So, while most folks use the HSA to reimburse themselves as they incur health care expenses, the ideal scenario is that you start with an HDHP with HSA when you are young (although this works for any age pre-Medicare), but do not reimburse yourself from the HSA (just pay from your checking account). Instead, invest the money in the HSA and use it like a stealth retirement account. This assumes, of course, that you can afford to contribute to your HSA while still paying any out-of-pocket health care costs out of your regular cash flow. (You can keep track of your health care expenses over time and reimburse yourself at any time, even for costs incurred in the past, as long as they occurred while you were enrolled in a high-deductible plan.)

The reason this is so powerful is that the money in your HSA never gets taxed (if you eventually use it for health care expenses), so it’s better than either a Traditional or a Roth 401k/403b/457/IRA. Ideally, you would max out your contributions to the HSA each year. For 2021, the limit is $3,600 for individuals or $7,200 for families (any dependent coverage), with a $1,000 catch-up contribution if you’re 55 or older. Keep in mind this includes the employer contribution, so subtract off $1,250 for individual or $1,700 for any dependent coverage to find out what you can contribute yearly (divide by 12 for monthly contribution). (And, if your spouse has their own HDHP with HSA through their employer, make sure to subtract off their employer contribution plus anything your spouse is contributing to the HSA.)

Then, once you’ve met the minimum that your HSA provider requires to be kept in cash (typically in the $100 – $2,000 range), you can set up an “automatic sweep” of any additional contributions into your investment account. You typically have a wide range of investment choices through someone like TD Ameritrade, so you can invest in low-cost, diversified index funds. Over time that money will grow and, again, will never be taxed. (Note that it is never taxed as long as you eventually use it for health care expenses. Once you turn 65, you can also use it for anything you want and pay taxes on it, but no penalty.)

In effect, you can use your HSA as another retirement account, in addition to your Traditional and/or Roth IRA, 401k, 403b or 457. But, unlike a traditional account (which is tax deferred, but you pay taxes when you withdraw), or a Roth account (which you pay taxes up front, but then withdrawals aren’t taxed), an HSA is never taxed (contributions are pre-tax, investment gains are tax free, and withdrawals are tax free). This is why HSAs should be near the top of your priority list for investing for retirement (second only to contributing to a 401k/403b/457 up to any employer match, and since most teachers don’t get an employer match, that makes HSAs your #1 priority).

So, let’s do a hypothetical to just give you an idea of what this could look like. Let’s take a 25-year old teacher just starting to contribute to their HSA. Let’s assume that in addition to the employer (district) contribution, they max out their HSA. Let’s also assume they have a spouse and therefore are able to contribute $7,200 per year into their HSA ($1,700 from the district, $5,500 from the teacher). For simplicity’s sake, we’ll ignore that the $7,200 will go up over time (and the current $1,000 catch-up provision once you and/or your spouse turn 55) and that they have to have a minimum amount kept in cash before they can invest (that will be more than made up for with the increases to the $7,200 limit in the future). We’ll assume they invest monthly in the Vanguard Total Stock Market Index Fund (VTSAX), and we’ll assume an 8% return per year. (Historically, the return would be higher than 8%, but going forward it may not be so going to be a bit conservative here.) We’ll assume they continue to invest $7,200 a year ($1,700 from their employer) for 40 years (until age 65, when they will be covered by Medicare), and then start withdrawing money for any accumulated or future health care expenses.

So, how much will they have at age 65? $1.8 million. Tax free (and the money has never been taxed). And it will continue to grow after that, since they are unlikely to pull the full $1.8 million right away. (And, at the historical return of closer to 10%, you’d have $3.2 million. Even at only 6%, you’d have over $1.1 million.)

Now, it may be unlikely that they’ll continue to teach until age 65, so they may lose the employer contribution before age 65. But, even if they do, they can still contribute up to the maximum with their own money, so the numbers still work. And given the fact that the $7,200 maximum per year goes up over time, and there’s the post-55 catch-up provisions, the final amount will likely be well over $2 million.

So, if you’re not currently using one of the high-deductible plans, consider switching. And consider maxing out your HSA each year and, to the best of your ability, paying for health care expenses out of your normal cash flow and let compound interest do its magic inside your HSA. This could end up being your best retirement account