An old friend wrote in with a question I thought I’d share. It’s a question asked by countless small business owners trying to navigate the complicated world of individual and family health insurance plans:
We’ve typically used high-deductible plans linked to a health savings account (“HSA”) plan in order to keep our monthly costs down and to get the tax break. But since, as small business owners, we can write off our monthly premiums through our business, is there still a financial benefit to an HSA? Or does it make more sense to drop the HSA and go with a lower-deductible plan and pay a higher monthly payment?
There are a lot of overlapping considerations here, and the needs of every family are going to look a little different. But there are some general guidelines to consider.
Never use a tax break as an excuse to overpay.
I see this a lot with home purchases, as plenty of people buy houses that are far bigger and more expensive than they need in order to get a larger mortgage interest deduction. We all like getting a tax refund in April, but you have to keep the deduction in context. You’re stuck with a larger monthly mortgage payment, and on a net basis you still have money flowing out of your pocket. You can easily go broke trying to save money.
Let’s bring it back to health insurance. Think of the tax benefits like this: If you are in the 20% tax bracket, you’re essentially getting a 20% discount. So, let’s say your existing high-deductible plan costs $500 per month. Your effective after-tax cost is $400 per month. Now, let’s say you can get a lower-deductible policy for $700 per month. Your after-tax cost would be $560.
Yes, you are “getting a bigger write-off,” in that you’re saving $140 per month on the $700 policy vs. $100 per month on the $500 policy. But you’re still paying $160 more per month ($560 – $400).
Look beyond the immediate tax break.
There is also the issue of the HSA account itself. Contributions made to an HSA account give you an immediate tax break, but it doesn’t stop there. If you end up not spending all of the funds on health-related expenses, you can invest them, effectively using the HSA as a de facto retirement account. All capital gains, interest and dividends grow tax free, and any withdrawals for qualified medical expenses are tax-free. Plus, once you reach age 65, all nonmedical withdrawals are taxed at your marginal tax rate, just as with a traditional IRA. (If you withdraw money for nonmedical expenses before you’re 65, then there’s a 20% penalty.)
In 2015, individuals can contribute $3,350 and families can contribute $6,650. And if you’re 55 or older, you can chip in an additional $1,000. Think of it as an “extra” IRA.
Don’t forget the purpose of health insurance.
From a personal finance perspective, the HSA is generally still the way to go. But I haven’t said a word about your health. As I said, all families are different, and if you are a heavy user of medical services (or the parent of a young child), the high-deductible plans that come with HSA plans might be a bad fit. You’ll pay less in monthly premiums but a lot more in doctor’s visits.
In the end, you’ll want to put a pencil to it and see what makes the most sense for your family. But the takeaway is that big tax write-offs only come with big expenses. I’d prefer to pay more in taxes if it meant my total monthly expenses will stay lower.
Photo credit: 401(K) 2012
Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.