Should Attorneys Use a Health Savings Account-Eligible High Deductible Health Plan?

A high-deductible health plan (HDHP) can be the right health insurance choice for high-earning attorneys. That’s because health saving account-eligible HDHPs offers the chance to save money not just on the cost of insurance, but also on the cost of taxes.

What is a High-Deductible Health Plan?

A high-deductible health plan (HDHP) is just what it sounds like: a health insurance plan with a high deductible. In 2021, an HDHP must have a deductible of at least $1,400 for a single person, and $2,800 for families. The out-of-pocket maximums are $7,000/$14,000 for single and family coverage in 2021, respectively.

What is a Deductible?

An insurance deductible is the amount you must pay out of pocket before the insurance company pays you any benefits. Most types of insurance have deductibles.

Consider your automobile insurance policy. You may have a $500 deductible on the Comprehensive and Collision coverage of your automobile. (Comprehensive and collision insurance is the portion of your auto insurance that protects that value of your car.) Here’s an example of how the deductible on your auto insurance works.

Your car is “totaled” in a traffic accident. Now, your auto insurance is on the hook to replace your car. If your car is worth $10,000, your auto insurance will only pay you $9,500.

Financial Loss – Deductible = Amount Paid to You by the Insurance Company

Deductible vs. Max-out-of-Pockets

In health insurance, there are not only deductibles but co-payments (copays) too. With copays, the insurance pays part of your medical bill. Both you and the insurance company each pay part of a medical bill until you reach an out-of-pocket maximum. Let’s use examples to show how this works.

You have an HDHP. You receive a medical bill for $100,000. The deductible in your HDHP is $2,800. Therefore, you must pay the first $2,800 of the bill. Once you reach $2,800, the insurance company then pays part of the bill – until you reach the out-of-pocket maximum of $14,000. If your copay is 50%, both you and the insurance company will each pay $11,200 on the next $22,400 of medical bills. After you’ve paid a total of $14,000 out-of-pocket, any further cost is covered by the insurance company.

HDHPs Save on the Cost of Insurance

Why would anyone choose a health insurance plan that could cost you $14,000 in out-of-pocket expenses? Because in the long run, using an HDHP could save you money – compared to using a health plan with a conventional (i.e., lower) deductible. In a vacuum, paying out of pocket means spending more money than not. However, paying out of pocket in combination with saving money on the cost of insurance (and saving on taxes, covered later) could save you money.

Looking at the cost of insurance alone, an HDHP is less expensive than health insurance with conventional deductibles. However, as illustrated in the example above – in the worst-case scenario – the max-out-of-pocket is more important than the deductible.

Self-Insurance

Insurance companies exist to turn a profit. They do this by collecting more in insurance premiums than they pay out in insurance benefits. If that wasn’t the case, the insurance company wouldn’t be in business. Therefore, when you purchase insurance, you lose – on average. That’s why it can make sense to skip insurance – if you can afford to do so.

Of course, we should still buy insurance when we need it – when the risk of going without insurance would be too great. That’s why buying health insurance still makes sense. However, we can look to see where we can self-insure for a portion of the costs where possible.

Let’s return to our automobile insurance example. We have a car worth $10,000. The collision coverage on our automobile policy has a $500 deductible. That means when the car gets totaled, we lose $500. However, we’re paying $20 for that $500 deductible. Were we to increase our deductible to $2,500, the insurance drops to just $12.

This begs the question:

Does it make sense to pay $8 more for an additional $2,000 of insurance coverage?

If you’re an attorney, the answer should be, “no.” That’s because you have $2,000. You don’t need to pay $8 for $2,000 in coverage. In a worst-case scenario, you could bear the cost of the $2,000 yourself. And if you do this, you will come out ahead – on average. Remember, insurance companies exist to turn a profit. So, on average – anything you buy from them will be to their advantage – and not yours.

Of course, sometimes we can’t afford a given financial loss ourselves. Long-term disability insurance is a good example of this. Quality long-term disability insurance costs thousands of dollars a year. And while we would come out ahead – on average – if we never purchased it, the risk of not purchasing it is too great. Unlike being able to cover the cost of a $2,000 out-of-pocket difference in a deductible, we usually don’t have the resources to self-insure for our lifetime income. (For those near retirement, they usually can self-insure for the balance of their career.)

Self-Insure with an HDHP to Save Money on the Cost of Insurance

With an HDHP, we can use insurance most efficiently: we purchase coverage to protect ourselves from a catastrophic expense. But, we self-insure on the smaller end ourselves. By self-insuring for a relatively small amount of medical expenses each year (up to $14,000 max out of pocket for families in 2021), we save money, coming out ahead – on average.

When deciding to self-insure with an HDHP, remember to look at not just the deductible but the max-out-of-pocket. As with deductibles on HDHPs, the max out of pocket is frequently higher than health insurance with a conventional deductible.

You should leverage your rainy day fund to cover these higher out-of-pockets with an HDHP. Assuming an emergency fund of at least three months of living expenses, an HDHP makes sense for any attorney.

Of course, this strategy makes the most sense with individuals (or families) with predictably low ongoing medical expenses. If you or someone in your family covered by the HDHP has some ongoing medical expenses, an HDHP may not be a sure bet. (Alternatively, for those hitting the deductible annually, an HDHP may still make sense.)

Tax Deduction for HSA-Eligible HDHP

Saving money on the cost of insurance isn’t the only reason to consider an HDHP. The other reason is to take advantage of the available contribution to a Health Savings Account and the tax deduction it offers.

For high earners, like attorneys, there is always more cash than there is room in tax-advantaged accounts. Many employer-provided retirement plan contributions are capped at $58,000 for 2021. (Those over 50 are entitled to another $6,500 contribution.) For those covered by a retirement plan at work, the deduction for traditional IRA contributions phases out with as little as $66,000 of income (or $105,000 for married filing jointly).

For an HSA-eligible HDHP, you can contribute $3,600 – or twice that for families. If you’re over 55, you can contribute an additional $1,000.

As with your contribution to your traditional 401(k), you get a tax deduction for this HSA contribution. You’re not taxed on that income: $3,600, $7,200, etc. For attorneys generating a healthy income, this is a very valuable tax savings.

Not all HDHPs are HSA Eligible

Just because a health insurance plan has a high deductible does not mean users of that plan can contribute to an HSA. The Internal Revenue Service (IRS) has several requirements for what determines an HSA-eligible HDHP. So, confirm that HDHP is indeed HSA-eligible before opting for the HDHP.

Tax-Deferred Growth

But, wait! There’s more: The tax savings available by using an HSA-eligible HDHP don’t end there. Once you’ve made your tax-deductible HSA contribution for the year, you can then invest that money. Money inside an HSA grows tax-deferred. So long as the money stays inside the HSA, you will not receive an annual tax liability on any dividend distributions or capital gains distributions from your investments.

Tax-Free Distributions with an HSA

If you thought a tax deduction and tax-deferred growth was the total of the tax advantages offered by an HSA, you’d be wrong. HSAs also offer tax-free distributions for qualifying medical expenses. If you pay out of pocket for a medical expense, save that receipt. That receipt entitles you to a tax-free distribution from your HSA.

Wrapping it all up, the HSA is triple tax-advantaged:

  1. Tax deductions for contributions
  2. Tax-deferred growth on investments inside the HSA
  3. Tax-free distributions for qualified medical expenses

This superb tax treatment makes the HSA the best tax-advantaged investment account in America. It’s better than your traditional 401(k). It’s better than your Roth IRA. If you only have $3,600 to invest, put that money into your HSA.

How to Use an HSA-Eligible HDHP

An HSA entitles you to tax-free distributions for qualified medical expenses. Therefore, save receipts for money spent on medical expenses paid out of pocket. Save them forever.

While the IRS requires medical expenses for tax-free distributions from an HSA, it doesn’t stipulate a time requirement between when you make the expense and when you make the distribution. Therefore, while you could distribute money from your HSA to reimburse yourself for a qualifying medical expense, you don’t necessarily want to. That’s because you’d be short-changing yourself on the tax benefit of the HSA: tax-deferred compound growth and tax-free distributions.

Therefore, the best way to use an HSA is to contribute as much as possible – and then invest those contributions for long-term growth. That means investing in a low-cost, broadly diversified stock fund – and not a bond or (even worse) leaving your HSA funds in cash.

Before making those tax-free distributions from your HSA, give your investments time to compound. After a decade or two or three, then make those tax-free qualifying distributions. You can even use your receipts from decades past to make those qualifying distributions. This is why it’s important to save all receipts for qualifying medical expenses.

The HSA is the Best Investment Account You Didn’t Know About

The HSA-eligible HDHP permits participants to contribute to an HSA, qualifying for a valuable tax deduction. Contributions to an HSA can be invested for long-term growth and be distributed tax-free. For attorneys with more cash than room in tax-advantaged investment accounts, they should use the best investment account in America: the HSA.

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