How do I save money for healthcare?

When I first came to the US many years ago as a student, I got sick and had to go to the doctor for the first time in the US. What followed was at that time a very bewildering experience for me. I needed to show my insurance card and then had to tell them who or if I had a primary care physician. I tried finding out how much the visit would cost but they kept telling me to contact my insurance company. After a few weeks, I received a bill and was taken aback looking at it. The reason I was bewildered and taken aback was because of two things – growing up in India, we did not have a concept of health insurance for everyday folks. We just went to the neighborhood  doctor and paid a fee when we visited. I always knew exactly how much I was going to pay and the fee was pretty nominal. So for most parts we never thought too much about it. As a result,I was in for a shock looking at both the different steps involved with insurance as well as the costs. For people living in the US, a lot of us know that Healthcare costs are one of the scariest parts of living here. They are so high and people sometimes cling onto jobs just so they can maintain their healthcare. In today’s article, I am going to talk about how we should think about saving money for healthcare both in terms of today as well as for the future in terms of retirement. In countries with nationalized health care systems or in countries where healthcare is still available at a very reasonable cost, this may not feel very relevant. However, I do think it’s pertinent to think about this because things continue to change and evolve world over on this topic. That said, the majority of what I detail in this article is very US-centric. 

Why should you care about this? 

Before we dive into the how, let’s first understand a bit more context on the why. Why should we be worrying about Healthcare? The obvious answer to this lies in the fact that healthcare costs are and will likely be one of the single biggest line items of expense for individuals and families in the US. The rate of inflation for healthcare expenses has generally been higher than that of the general rate of inflation. Now, most of us don’t really think much about health care costs or premiums when we are still working, other than during open enrollment season in the US. While we see premiums go up each year, what we don’t see in the background is the employer’s share of the premiums are much higher and also are going up significantly. If we did not have a job, we would be paying that portion too and then, it would definitely be a sticker shock. As of today, if we were to purchase healthcare in the open markets, the national average expense for premiums for an individual is around $6000 per person per year for a 40 year old¹. This can be higher or lower depending on the state you live in, whether you are covering a portion or all of your family and finally the coverage you are looking for. 

However, as we think about retirement, it is a well studied and documented fact that healthcare costs are an even more significant portion of a retiree’s budget. People make the mistaken assumption that medicare will pay for everything once they turn 65. You still have to pay for the deductibles and other out of pocket expenses. According to a Fidelity study, an average couple aged 65 will need to budget approximately $300K over the rest of their life span for healthcare expenses.² These expenses don’t include the cost of long term care (care needed for any critical or chronic illnesses that prevent you from caring for yourself) which can be exponential. Overall, needless to say planning for health care expenses both for today and tomorrow is very important. 

What options do I have for saving for healthcare?

At this point, you may ask why is saving for healthcare different from saving for retirement? Meaning, why should I have or use any different vehicles other than our 401Ks, Roth IRAs, IRAs etc. All of those are valid vehicles to save money in but if you live in the US, you have a few different options that are healthcare specific. Only the first one (HSAs) is a long term healthcare savings tool, the rest of them are near term (for current year) healthcare savings tools only. 

1. Health Savings Accounts (HSAs) – I call HSAs the king of all savings vehicles specifically for healthcare or the triple sundae because of its triple tax advantages 🙂 – it is by far the most tax advantaged account out there and is a phenomenal tool to save money for healthcare. In order for your healthcare plan to qualify for an HSA, it needs to be a High Deductible Health Plan (IRS defines this as a plan that has a minimum deductible of $1400 for individuals or $2800 for families; max out of pocket expenses of $7000 for individuals and $14,000 for families in 2021). I will discuss HSAs and how to use them in more detail later in this article. But this is the account to use for long term savings for healthcare. 
2. Healthcare reimbursement accounts or Arrangements (HRAs)  – these are different from HSAs and are short term savings vehicles that are fully funded by an employer and are part of benefits an employer may offer. These are owned by the employer and if they don’t get used by the end of the year, you lose the money.  These do not need to be associated with high deductible health plans. Generally, you cannot have an HSA and an HRA with some exceptions that I won’t go into. 
3. Healthcare Flexible Spending Accounts (FSAs) – Healthcare FSAs are generally accounts where employees can contribute pre-tax dollars during open enrollment (2021 max contribution is $2750) that can be used for healthcare expenses. This is also similar to an HRA where it is use it or lose it – meaning, you lose the money you contribute if you don’t use it up by the end of the year. Typically FSAs unless they are limited purpose FSAs cannot be used along with an HSA. 
4. Limited purpose healthcare reimbursement accounts (LPFSA) – we are getting into the alphabet soup here now 🙂 But basically this is an account that employers can offer but need to be typically funded by the employee during open enrollment season for specifically dental and vision expenses. Everything else is similar to an FSA. The only difference is you can contribute to an LPFSA and an HSA at the same time. This is what I do currently. 

The Health Savings Account – the triple Sundae!

I want to dedicate an entire section of this article to the HSA because I really believe this is a phenomenal way to save for healthcare but as I will explain, you can be smart about how you use this. 

First, let’s understand the basics. An HSA is very similar to a 401K or a taxable brokerage account where you can invest your contributions into the stock and bond markets or choose to keep it in cash. You own this account and similar to your 401K, you can decide where to invest the money. These are relatively new and became law in Jan 2004. You can keep your HSA even if you change employers. You can open your own HSA as long as you qualify per IRS requirements. So let’s understand why this account is so amazing. It lies in the triple tax advantage:

1. Your contributions into an HSA are 100% tax free similar to a 401K. If this is offered by your employer as part of what is called a cafeteria plan (Sec 125 plan), these are also exempt from any payroll taxes. So these can be deducted from your paycheck each month. The max contribution limits in 2021 are $3600 for individuals and $7200 for families. 
2. The money in an HSA grows 100% tax free similar to a 401K or Roth IRA. If you invest the money (and I strongly recommend you do that and not keep it in cash) in stocks and bonds, the money will compound and grow over time. 
3. Withdrawals for qualified healthcare expenses are 100% tax free! As long as you use the money for healthcare expenses, this is tax free. Now, if you withdraw it and use it for non-medical expenses before 65, you will pay ordinary income taxes and a penalty. If you withdraw your money after 65 for non-medical expenses, you will stay pay ordinary income taxes but no penalty. 

The final icing on the cake is that a lot of employers will throw in some additional ‘free’ money in an HSA. For eg. My employer contributes $1000 each year into my HSA. Note that this counts against the max contributions. 

Think about that! This is literally the only legal account and method in the US to get money tax free, allow it to grow tax free and withdraw tax free. Uncle Sam will not take a single piece of this! Now, there is a reason for this – it goes back to what I started the article with. The politicians saw the big challenge with healthcare costs growing exponentially and wanted to encourage individuals to save money for healthcare and offer this really special account to incentivize people to do so. 

Using your HSA in a smart, strategic way

So now, let’s talk about a couple of smart strategies on how to use your HSA. 

When I first started using HSAs, I simply put in just the amount of money to meet my deductible each year (was around $3000 – $4000) and kept the money in cash and simply paid for all my expenses with my HSA money. I was feeling pretty smart because I was using tax free dollars to pay for my medical expenses – pretty smart right? Not really. I was essentially using an HSA like an FSA and not taking advantage of the benefits of an HSA. 

So finally after I saw the light a few years ago, I did a few things – one, I maxed out the HSA contribution instead of just contributing only the deductible amount; two – I moved the money from cash and invested it into a broad market index fund (this happened to be through Fidelity and was one of those 0% expense ratio funds); three – I kept the money invested and decided not to withdraw it for any ongoing medical expenses instead paying out of pocket by cash (with after tax dollars). You may ask why I did the last item. Well, it was simply this – I was foregoing years of tax free growth by spending it on $200 and $300 medical bills in the current year. That same $200 or $300 if invested would grow to almost $1000 tax free in 20 years (assuming a 7% return). Now that seems like a small amount and too long a period but imagine the account had tens of thousands of dollars – think about the power of compounding then. That’s a lot of money you would be leaving on the table. 

Now, there is a final hack or smart strategy I started doing last year which is something I would also recommend. I started saving all my medical bills on a google drive. I scan them, organize them into folders for each year, and have a running tally of the expenses in a spreadsheet. Why do I do this? The HSA has this rule that you can withdraw money for qualified medical expenses at any time in your life. So lets say I have accumulated $100K worth of medical bills over 20 years and let’s assume my HSA has grown to $100K in 20 years. Well, I can either continue to keep the HSA and use it for future expenses or simply use my medical bills to withdraw the $100K at that point because they were all qualified expenses. Now, suddenly you don’t need to worry about the money being locked in the HSA until you can use it for medical expenses in the future. You have already accumulated the bills – you can withdraw it and use it for whatever you want! This is a really amazing strategy and something that gets me all pumped up as you can see. 

My goal is to continue contributing and investing in the HSA till I am legally allowed to, and allow that account to grow tax free. I know medical expenses in retirement are going to be significant irrespective of whether or not we are in good health (even preventative care has become expensive these days). 

What about long term care?

I am not an expert on this but I briefly touched on it earlier in this article. Long term care is essentially needing specific care for a short term or a longer term period as you grow old. This is planning for a situation where you may be struck with a disability or chronic illness preventing you from taking care of yourself. More information on long term care can be found in this link: https://www.nia.nih.gov/health/what-long-term-care  In the US and some other countries, you can buy long term care insurance that essentially helps cover the costs of these medical expenses related to long term care (that are typically not covered by your regular insurance). Many experts say the best age to start buying long term care is between the ages of 45 and 55 (the younger you buy it, the cheaper it is but of course, the longer you are going to pay for it). Most people end up buying it in their 50s. Long term care insurance is a product that has come under a lot of fire recently because the insurance companies had grossly miscalculated the premiums needed and had to significantly jack them up. There are other ways to budget for something like this including saving a ton of money in your HSA. Whatever you do, consider long term care in your healthcare savings planning.  

Staying healthy is the ultimate healthcare savings strategy

Ultimately, after all the reading I have done on this topic, I recognized the reality – which was that the one thing I could control (at least based on what I know about my health for now – I recognize this can change over time) was the best way to reduce your healthcare expenses is to stay healthy. Similar to my passion for personal finance, over the last year or so, I have embarked on a journey to understand and implement the pillars of staying healthy. I am by no means an expert and I am not qualified to blog on that topic. But after learning from a lot of experts, I have been working hard to try and build consistency around eating healthy, staying active, getting enough sleep and doing preventative health check ups and monitoring my biometrics. I have no idea if this will keep me healthy for the rest of my life but that’s what I am attempting for anyway. Time will tell if that works. But ultimately the obvious point is if you stay healthy, you can avoid/reduce the use of healthcare services. Now, the paradox here is – the longer you live, the more $ you need for your healthcare 🙂 but hopefully this is a strategy to live your life for most parts disease-free. I recognize these are not entirely in our control and in our modern age, we are susceptible to all sorts of diseases or as we learnt in 2020-2021, pandemics. 

Concluding thoughts

I do not mean to end my article on a somber note. I have always been a bit terrified of the prospect of having to pay for excessively high healthcare expenses. I had a conversation with my financial advisor earlier this year and his feedback to me was – from a pure financial perspective, you just need to plan and budget for it like any other line item. If you are very fortunate and have a ton of money, you can plan for the absolute worst case scenario but for most of us, we can plan for an average or above average scenario and beef it up with forms of insurance. The reality is that a ton of people in the US dont budget for it at all and get financially devastated when a healthcare event occurs. None of this is to scare my readers but simply to push everyone to start thinking about this. You can absolutely save enough money for this and ensure a comfortable retirement. The sooner you start saving and investing in this, the better because you can enjoy the power of compounding.

Thank you for reading this article and I wish you success in your financial journey!  

Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.

Sources:

1. https://www.valuepenguin.com/average-cost-of-health-insurance 

2. https://www.fidelity.com/viewpoints/personal-finance/plan-for-rising-health-care-costs