Chronic Illness? High Tax Bracket? Opt for the HDHP

Here is my article published in LifeHealthPro, re-posted on my own blog.

HDHP's for the Young & Healthy

It is often suggested that those in good health should opt for a High Deductible Health Plan (HDHP) (Waggoner 2013, Cannon 2013, Lahey 2012 , Miller 2014). The logic behind the argument is relatively simple:

A high deductible health plan will save a healthy person money. This savings comes from the low health insurance premiums, and the absence of ongoing medical care. HDHP premiums are much lower than the premiums of conventional health insurance plans – insurance plans with conventional deductibles. Since preventative care is included at no - or reduced - cost, there is considerable savings available with a HDHP. 

It is a relatively simple formula:

Low Premiums + Free/Low Cost Preventative Care = Savings 

The Bogleheads Approach to High-Cost Healthcare: Total Return

This begs the question: if you’re unhealthy, should you opt for a conventional health plan? Not necessarily. Bogleheads makes the point: 

You are most likely to benefit from an HDHP if you are either in good health or have very high prescription drug costs. 

Why? Because a HDHP effectively caps your liability. To illustrate, consider a fictitious example:

Themistocles is in poor health, with high ongoing medical expenses. Each year, Themistocles must pay medical expenses, including prescription drug costs, to the tune of $100,000. Themistocles can choose either a HDHP or a conventional “platinum” level plan. Irregardless of the plan selected, Themistocles will reach the out-of-pocket maximum.

You can see in the chart above that the answer is clear: even though the HDHP has a higher deductible, the cost savings offered by the lower premiums more than makes up for the higher out-of-pocket maximum. For the individual undergoing high cost healthcare, the HDHP is the superior choice. Bogleheads is correct. Themistocles saves $458 by opting for the HDHP.

Low Premiums + Capped Liability = Savings

But, this comparison ignores one important variable (and the topic of this post): Health Savings Accounts (HSA) and the tax benefits available when utilizing them.

Health Savings Account and Tax-Deductions

 Tax-deductible contributions are made to a Health Savings Account (HSA) and are withdrawn tax-free to pay for qualified medical expenses (Internal Revenue Service 2013). Going back to our example:

Themistocles is in poor health. As such, he contributes the maximum he can into his HSA account each year, $3,300 (Internal Revenue Service 2013). He does this because he knows that he will  reach his HDHP's out-of-pocket maximum. Having made the contribution to the HSA, Themistocles now has a tax deduction.

For those taking the Boglehead approach to high-cost health care, the tax-deductible contribution changes the after-tax cost of selecting an HDHP by a function of the individual's tax bracket.

This means that for Themistocles, the HDHP turns out to be an even better deal; instead of savings just $458, Themistocles is now looking at a savings of as much as $1,765.

Granted, the tax-advantaged Bogleheads strategy is only useful for those who know ahead of time that they are going to incur high medical expenses. For those with high ongoing medical expenses, the higher tax bracket one is in – the better a deal a HDHP is.

In short, if an unhealthy individual opts for a HDHP, hitting their deductible annually, the tax savings offered by an HSA in combination with a HDHP's low premiums - but capped liability - makes for significant  savings.

Low Premiums + Capped Liability + Tax Deduction = Great Savings

Consider the matrix below for deliberation on opting for a HDHP.

In the Middle

For those in the middle, individuals with moderate ongoing medical expenses may be best served by electing a conventional plan. With a HDHP, the individual may have to pay many costs out of pocket but never reach the deductible – the point at which the HDHP begins paying benefits. Consider:

Darius must see a chiropractor every month for a treatment costing $335 per visit ($4,020 annually), which Darius would have to pay out of pocket were he to elect a HDHP. (The chiropractor's treatment does not qualify as preventative). Though the expense of the chiropractor visits add up, the total out-of-pocket is not enough to get Darius to the top of his deductible.

Were to Darius to elect a conventional health plan, he would only be liable for a $40 copay for each visit ($480 annually). However, Darius would be liable for higher monthly premiums than that charged by a HDHP.

With such a narrow margin between the sum of all out-of-pocket expenses and the deductible, the tax deduction offered by HSA contributions play an important role in determining which health plan is the superior choice. When in a 10% tax bracket, the HDHP proves the inferior choice.

 In a higher tax bracket, a HDHP proves a wise move:

 However, if out-of-pocket expenses rise far above the amount that can be deducted with HSA contributions, then the conventional plan - with its high premiums but low co-pays - wins out:

Takeaway

The matrix below summarizes the article:

The individual in the high tax bracket, and in poor health, (dark green box) has the greatest potential to benefit by utilizing a HDHP. Not only will the individual will be paying low premiums for a defined out-of-pocket maximum, but the individual will benefit greatly by paying for those expenses with severely discounted after-tax dollars. For the individual in poor health and in the high tax bracket, the HDHP is extremely advantageous.

The individual with moderate health issues (yellow & red boxes) will need to decide if the tax benefits offered by a HSA will balance the out-of-pocket expenses required in a HDHP. This may be the case if the individual is in a high tax bracket (yellow box), with the out-of-pocket expenses hovering near the maximum allowable contribution ($3,300 for individuals). While the out-of-pocket expenses may be high, the combination of the low premiums and the tax savings with HSA contributions may render the HDHP election worthwhile. However, the individual in low tax bracket with moderate health expenses (red box) should opt for a conventional plan, and not a HDHP.

Individuals in good health (top row, light green boxes) will pay smaller premiums and little, if any, out-of-pocket expenses. Those individuals in good health are less able to take advantage of the tax-savings offered to the degree that an individual in poor health can.

An individual in poor health in a low tax bracket (lower left) will have their out of pocket expenses capped annually. Though still a good fit, this low-tax-bracket-individual will not be able to generate as much tax savings as an individual in a high tax bracket.

Works Cited 

Cannon, Ellen. "Ask the Readers: High-deductible health insurance: yea or nay?" Get Rich Slowly. November 8, 2013. http://www.getrichslowly.org/blog/2013/11/08/high-deductible-health-insurance/.

Covered California. "Your Options." Covered California. 2013. https://www.coveredca.com/shopandcompare/#healthplans.

FairHealth. "Understanding High Deductible Health Plans." FH Consumer Cost Lookup. 2014. http://fairhealthconsumer.org/reimbursementseries.php?id=27.

Internal Revenue Service. "Instructions for Form 8889." Internal Revenue Service. 2013. http://www.irs.gov/pub/irs-pdf/i8889.pdf.

—. "Publication 969." Internal Revenue Service. 2013. http://www.irs.gov/pub/irs-pdf/p969.pdf.

Kaiser Family Foundation. "Kaiser Family Foundation." 2013 Employer Health Benefits Survey. Aug 20, 2013. http://kff.org/report-section/2013-summary-of-findings/.

Lahey, Joanna. "HDHP with HSA: friend or foe?" Get Rich Slowly. Nov 17, 2012 . http://www.getrichslowly.org/blog/2012/11/17/hdhp-with-hsa-friend-or-foe/.

Miller, G.E. "What is a High Deductible Health Plan (HDHP)? Updated for 2014." 20 Something Finance. January 5, 2014. http://20somethingfinance.com/what-is-a-high-deductible-health-plan-hdhp/.

Story, Louise. "Health Savings Accounts Gain Momentum." Wall Street Journal. Sept. 9, 2004. http://online.wsj.com/news/articles/SB109468408162712961.

Waggoner, John. "Is a high-deductible health plan right for you?" USA Today. September 24, 2013. http://www.usatoday.com/story/money/personalfinance/2013/09/24/high-deductible-health-care-plans/2848181/.

Zamosky, Lisa. "Many opt for high-deductible health plans despite risks." The Los Angeles Times. May 5, 2013. http://articles.latimes.com/2013/may/05/business/la-fi-healthcare-watch-20130505.