Uncle Sam isn’t just going to hand you over a tax-exempt health savings account (HSA) without something in return. They want us to have some skin in the game. Risk, as I like to call it. Taking on risk is actually one of the eligibility requirements, and the IRS uses a high deductible health plan (HDHP) to create that risk.
That makes the high deductible health plan the bedrock of the health savings account. It’s the yin to the health savings account’s yang. But what is it and why do we need one?
In part one of this series, we covered the health savings account (HSA) from a high level. We learned it is a special tax-exempt account we can use to pay medical expenses. Only about 24% of employees who get coverage through their employer are covered by an HDHP with an HSA option in 2020.
Max’s weird infatuation with these accounts is already starting to rub off on the internet masses. But before everyone runs down to the corner of healthcare and personal finance to pick themselves up a brand new account, there are a few more things to learn.
First, we need to make sure we are eligible to both open the health savings account and make contributions. The first step in being granted that eligibility by the IRS is getting health insurance coverage through a high deductible health plan.
Qualifying for a Health Savings Account
The Internal Revenue Service outlines four relatively simple criteria we need to meet to be able to open and contribute to a health savings account. These are outlined in Publication 969. There, they summarize one thing we “must do” and three things we “cannot do” to be eligible for HSA contributions.
Since the “must do” is one of the hardest hurdles, we will dedicate an entire post to it.
You must be covered under a high deductible health plan.
A high deductible health plan is just that, a plan with a high deductible. That deductible is generally higher than most health insurance plans. Usually, an employer will market the plan as a high deductible health plan with an HSA option.
High Deductible Health Plan
Like me, most people turn to their employer to try and get one of these “risky” insurance policies. Unfortunately, not all employers offer them. According to my friends over at the Kaiser Family Foundation, only 20% of all firms offered an HDHP with a health savings account option in 2020. That’s low. But the larger the firm, the more likely it is they will offer it.
I have worked for two large health systems during my career. One with about 5,000 employees and another with over 20,000. Both offered a high deductible health plan with a health savings account option.
For those who don’t have employer health insurance, there are a few HDHP options on the exchange markets as well.
High Deductible Health Plan Requirements
For a plan to qualify as a high deductible health plan, certain requirements must be met. The IRS wants us to take on some risk in exchange for providing us with a tax-exempt account. The high deductible sets up that risk. It puts us on the hook for our first several hundred dollars of healthcare services before our insurance kicks in and starts paying.
The nice thing is, they also put a cap on our risk with an out-of-pocket maximum. Or, as I like to call it, the max out-of-pocket.
The IRS sets a minimum deductible amount each year for self-only and family coverage that the plan must have to qualify as an HDHP. The plan is not allowed to provide any benefit payment until that bucket is filled up. This is where our risk comes into play. The exception is preventive care.
These minimum deductible amounts are adjusted for inflation each year using the consumer price index (CPI) and rounded to the nearest multiple of 50.
According to the IRS, the minimum deductible for self-only coverage in 2020 is $1,400. Inflation has been marginal, so that amount will stay flat in 2021 at $1,400.
For family coverage, we double that. The minimum deductible in 2020 for family coverage is $2,800. That amount will also stay the same for 2021.
Keep in mind this is just the minimum. The employer can go higher than this if they want. My employer sets me up with $500 more risk on the front end of things than the minimum.
Here is the Max Out of Pocket crew’s deductible for our HDHP for 2020.
Since our family deductible is more than $2,800, we meet the minimum deductible requirement by more than $500.
Careful on those individual deductibles, though. The IRS specifically calls these out. If your high deductible health plan has an individual deductible embedded into the plan, those individual deductibles need to be at least $2,800 as well. Like most HSA/HDHPs, my plan does not carve out an individual deductible.
This is how the IRS described the scenario.
Example. You have family health insurance coverage in 2020. The annual deductible for the family plan is $3,500. This plan also has an individual deductible of $1,500 for each family member. The plan doesn’t qualify as an HDHP because the deductible for an individual family member is less than the minimum annual deductible ($2,800) for family coverage.Publication 969 – I updated their numbers to reflect 2020.
Although they want some skin in the game, the IRS does limit our financial risk with these plans. They put in out-of-pocket maximums to limit our financial exposure to health care expenses.
The plan’s max out-of-pocket must be less than $6,900 for self-only coverage and $13,800 for family coverage in 2020. For 2021, these limits will increase to $7,000 and $14,000, respectively. Those are big numbers and something you definitely want to consider before signing up for one of these plans. On this end of things, the employer can go lower if they want to.
Here is our max out-of-pocket.
Our family max out-of-pocket is limited to $6,600. Since we are under the limit set by the IRS, our plan meets the out-of-pocket maximum requirement as well. Considering we have over $50,000 in our health savings account at this point, our max out-of-pocket is no longer a scary thing for us.
Getting access to a high deductible health plan is really the first step in establishing the health savings account. Without it, you can’t contribute. Usually, the best place to look for one of these is your employer. The larger the employer, the more likely they are to offer it.
In order for the IRS to grant us access to the tax-advantaged account, they expect us to have some skin in the game. Financial risk, if you will.
Understanding this risk is an important factor when deciding to sign up for a high deductible health plan. Can you afford to shell out a few thousand dollars when you miss that step and break your ankle? Are you willing to put in the work to set aside some money to cover your deductible?
The nice thing is, they limit that risk with an out-of-pocket maximum. But even that can be a shock to the budget when first starting out in personal finance.
Are you prepared to shell out the first $1,400 for healthcare services in order to get access to the health savings account?
I am not a tax professional and this is still not a recommendation to open a health savings account or enroll in a high-deductible health plan.