Having “tax free” HSA dollars may be better than having low copays for doctor visits.
The major benefits of health savings accounts are due to the ability to use “tax free” dollars to pay for health care expenses. It is often true that using tax free dollars is better than having office visit copays and much better when you’re faced with large and unexpected medical bills. But, to understand the magical powers of a health savings account, you need to understand taxes. Ugh.
The taxes that are withheld from your paycheck –
When you earn wages, your employer is required to withhold three types of taxes before you get your paycheck:
Example: Single Filers earning $36,901 to $80,350
Married Filers earning $73,801 to $148,850
|TOTAL TAXES WITHHELD:
We will round to 33% for simplicity sake.
So, for every $100 you earn, your employer is required to withhold $33 in taxes (33% x $100 = $33). You would then be left with $67 in your check. Keep this in mind as you read on to learn about how health savings accounts (HSAs) reduce your tax liability.
The basics of HSAs
In order to qualify for a health savings account you need to have a high deductible health plan that ALSO does NOT have copays for office visits and prescription drugs. Not having copays can sometimes worry employees. It shouldn’t and here’s why. Insurance plans without copays have lower premiums, which allows you to put money into a tax-free health savings account that you would otherwise be paying towards a higher premium for a plan that provides copays.
Let’s look at an example of someone who is age 40.
|Bronze 60 HSA
||$75/mo or $900/yr
Which is better – to pay an additional premium of $75 monthly to get a Silver 70 health plan that offers copays for office visits and prescription drugs? Or is it better to put that additional $75 into a health savings account. The key to understanding is best determined by knowing how much you need to earn in order to afford a copay.
Let’s look at a typical office visit copay
If your copay is $50, you need to earn a larger amount, since your earnings are taxable. In our earlier example, we determined that if your annual gross income as a single taxpayer is between $36,901 and $80,350 ($73,801 – $148,850 for married filers) you would be paying 33% (rounded) in taxes (Federal, Social Security and Medicare). So, how much do you have to earn in order to be left with $50 to pay your doctor’s office copay?
How we get there mathematically:
- Amount earned = Amount of copay ÷ (100% – tax bracket)
- Amount earned = $50 ÷ (100% – 33%)
- Amount earned = $50 ÷ 67% = $75 (rounded)
That means that the “real cost” for you to pay that $50 copay is $75, since that’s what you must earn to have enough left over after taxes to pay the copay.
Ballpark it with this quick method:
For people who fall within the 20-28% Federal tax bracket (including our example above), there’s a simple “ballpark” method to figure out how much you need to earn to pay a medical bill. Simply compute one half of the bill and add that amount to the total bill.
In our example, the bill is your copay, which is $50. One half of $50 equals $25. Add $25 back into the total copay of $50 and you get $75. Therefore, you need to earn $75 in order to pay a $50 copay.
NOTE: This method only works for taxpayers falling within the 20-28% Federal tax bracket, which is most people.
The HSA-qualified health plan negotiated fee versus a copay
When you have an HSA-qualified health plan with NO copays, you pay a negotiated fee to see the doctor. For example, a family practice or general doctor might charge $100+ for someone without insurance but when you show your insurance card, you get the negotiated fee which might only be $65 for a simple office visit.
You’ll recall from the chart above, the Bronze 60 HSA health plan allowed you to put $75 each month or $900 a year into the HSA and avoid paying taxes. So, when you pay that $65 negotiated doctor fee, you do so with tax-free money out of your HSA account!
As a reminder, with the Silver 70 or any non HSA-qualified health insurance plan, you need to earn $75 just to have $50 left over for the doctor’s visit copay.
Conclusion – Often paying for routine doctor visits with your HSA ($65) will be roughly the same as what you need to earn to pay a copay (earn $75). When you understand taxes, then you can figure out how much you have to earn.
So, is an HSA-qualified health plan right for you?
Assuming you fall into the 20-28% Federal tax bracket, like many Americans, then YES an HSA-qualified health plan is right for you.
Using tax-free dollars from your HSA will make visits to the doctor about the same as paying a copay for a doctor visit, HOWEVER with the HSA you get the added benefit of growing your investment over time for your medical needs during retirement – in other words tax-free dollars go into your HSA and tax-free dollars come out for medical needs.
That’s the next magical step . . . it’s what I like to call, “Super Charged Medical IRAs.”