Ch. 18:  Health Insurance

18.0 Introduction

            I don’t know if you’ve heard, but health care is kind of expensive here in the United States.  In 2022, the average US citizen was responsible for about $12,500 in medical expenses, which is nearly double the per capita spending of countries that are economically similar to the United States.[1],[2] Things probably won’t get cheaper moving forward.  While medical inflation has slowed since the onset of Covid-19 pandemic, there is a long-run trend for medical costs to outpace inflation. 

Since medical costs are so high, it should be no surprise to readers that medical insurance is also expensive and becomes more costly by the year.  But you still must buy health insurance; it’s a cost you simply can’t afford to avoid.  If a medical emergency befalls you or your family, health insurance can save a life, prevent financial ruin, or both. 

18.1 What’s the Point of Insurance?

            Suppose you and nine friends are going on a dangerous hike across the Rocky Mountains.  It is certain that exactly one of you will be attacked by a grizzly bear.  The bear won’t kill you, but the unlucky victim will have to pay $100,000 for medical care related to the attack.  Without insurance, you’ll begin this trip with a 90% chance of having $0 in medical costs and a 10% chance of facing $100,000 in medical costs.  This is quite a risky trip! 

  To reduce risk, you and your friends might pool your money together.  If the ten of you each contribute $10,000, you will have a combined $100,000, which is enough to cover the medical cost for the hiker that becomes bear fodder.  By pooling your money, you eliminate financial risk.  You will now each spend $10,000, regardless of whether you are the unlikely victim.  Unfortunately, getting your friends to all agree to create an insurance pool proves impossible.  If only five of your friends agree to pay $10,000, that’s only $50,000 in funds… not enough to cover an attack.  So, you would need to purchase bear insurance from a licensed insurance dealer.  Perhaps an insurer would charge you $12,000 for a bear attack policy:  You pay $12,000 up-front and the insurer will cover your $100,000 medical cost if you suffer an attack.  From a pure mathematical standpoint, this $12,000 expense is a “bad deal” since the fair cost of such a policy should only be $10,000.  But that doesn’t mean it’s not a reasonable purchase!  By spending $12,000, you transfer the risk of a $100,000 expense to the insurance company.  A bad deal mathematically… but a good deal from a risk avoidance standpoint.  "Bear attack insurance" doesn't exist, but health insurance does and it functions similarly.

  For low-cost expenses, insurance is unnecessary.  For example, I bought a $200 pair of noise-canceling headphones the other day and was offered the opportunity to pay $40 to buy an insurance policy that will replace my headphones if they break.  Just like the $12,000 bear insurance policy, this $40 expense is a “bad deal” mathematically.  But unlike the bear example, the stakes aren’t high enough to necessitate insurance.  If my headphones break, I’ll just buy a new pair!  A $200 expense isn’t going to ruin me financially, while $100,000 just might.  Similarly, Elon Musk doesn’t need bear insurance, he can just pay the $100,000 out of pocket if he’s attacked by a bear.  Thus, one only needs insurance when potential losses from an adverse event are high.  You need health insurance, auto insurance, home insurance, etc.  You don’t need insurance for your freaking toaster. 

  Do you need life insurance?  Maybe, maybe not.  Remember that insurance is useful when it protects you against the possibility of a financial disaster.  I have two kids.  If I were to die right now, my wife would have difficulty supporting the kids on her own and indeed, there would be massive adverse effects on my loved ones from a financial standpoint.  If my wife and I both die, the financial effects on my children would be massive!  The risks are too large for me to ignore.  On the contrary, if you are a college student with no dependents, there is no great need for life insurance.  If you die, everyone will be sad, but no one depends on your income. 

  Do you need health insurance?  Yes.  There are few absolutes in financial planning, but this is one of them.  All of us face the possibility of a car wreck or a cancer diagnosis.  Without health insurance, we face the prospect of complete financial collapse and/or inadequate medical care.  The stakes are too high to ignore.

18.2  The Onset of Coverage

            If you are an employee of a firm or government entity, it’s very likely you will be offered health insurance as part of your benefits package.  While there is no obligation to buy health insurance, employers typically subsidize the cost of health insurance.  Thus, employer sponsored health insurance will be much cheaper and/or of higher quality than what can be purchased on the free market.[3]

            Nearly all health insurance plans require monthly payments, called premiums.  For example, you might have premiums of $150/month.  If you fail to make payments, you run the risk of losing your insurance coverage.  But if you are enrolled in an employer-sponsored plan, payments will be made automatically via a paycheck deduction (much like 401(k) contributions).  Thankfully, health insurance premiums reduce income taxes, Social Security taxes, and Medicare taxes.  So, if you pay $1,800 in premiums, your taxable income is reduced by $1,800.  As such, the effective cost of health insurance premiums is lower than the price tag.[4]

            In the United States, parents and guardians have the option (but not the obligation) to keep their children on their health insurance plan until the child reaches age 26.  If your parents let you stay on their plan, thank them, and happily agree!  Once you reach age 26, you will begin your own health insurance coverage.  The exact timing of this varies by plan, but it is common to lose health insurance the day you turn 26.  For the remainder of your life, you will (typically) only be permitted to make changes to your health insurance coverage once per year during the open enrollment period.  Open enrollment lasts a couple of weeks and usually takes place in the fall.  From October 23rd to November 3rd of 2024, I was able to make my 2025 health insurance elections with my employer provided health insurance.  After November 3rd, I cannot make any changes to my coverage.[5]  Aside from open enrollment, the only time a person can make changes to their coverage is if they experience a qualifying life event, such as the birth of a child, divorce, marriage, or change of employment.  Because one cannot typically change health insurance easily, it is vital that you carefully make your health insurance elections during the open enrollment period.  Typically, you will have two to four general health insurance plans to choose from.  Picking a health insurance plan is the most important decision of open enrollment, but it’s one of many selections you will need to make.  Most employer sponsored plans also offer the option to contribute to life insurance, dental insurance, disability insurance, and more.  I’m choosing not to discuss these topics here, but you should plan to explore these topics when the time comes.

18.3. Types of Health Insurance Plans

            There are four common types of health insurance plans that could be offered by your employer.  While many small businesses offer only one health insurance plan, most government employers and larger businesses provide two to four choices.  Nationally, about two-thirds of employees have more than one employer sponsored health insurance option—hopefully you fall into this group so that you can choose a plan that fits your needs.[6]  The features and costs of these plans may greatly differ, so you need to be careful when making a selection. 

  In most cases, once insured, your health insurance plan will provide preventative care totally free—annual physical, vaccines, etc.  These expenses are usually quite cheap anyway, so the value of free preventative care isn’t substantial.  Most medical expenses do not fall into the realm of preventative care.  Other expenses (routine doctors’ visits, childbirth, surgery, etc.) are often paid completely out-of-pocket initially.  This is often a surprise to new health insurance owners.  If you go to the doctor for a sinus infection in January 2025, you will pay that expense yourself—your insurer pays nothing.  The amount of spending you must make before the insurer begins to chip-in is called a deductible.  For example, you might select a health insurance plan with a $4,000 deductible for the 2025 calendar year.  This means that you will pay 100% of your expenses out-of-pocket until you have spent $4,000.  Most insured folks do not reach their deductible in a year, so their insurer pays nothing. 

  But if you do reach your deductible, you will enter the next phase where you and the insurer share the burden of medical costs.  This is called coinsurance.  For example, your health insurance plan might have a deductible of $4,000 and a coinsurance rate of 10%.  This means that you will pay the first $4,000 in expenses out of pocket.  Once $4,000 is reached, additional expenses will be paid 90% by your insurer and 10% you will pay out of pocket.  So, once a deductible is reached, a $200 medical expense will only cost you $20. 

  If you have substantial medical costs in a given year, you may reach a spending limit where the insurer pays for all expenses.  This limit is called the out-of-pocket maximum.  A $10,000 out of pocket maximum means that you would never pay more than $10,000 for medical costs each year (but this doesn’t include premiums; those have to paid too).  To review, there are three spending phases within many health insurance plans:  initial spending (100% out-of pocket), coinsurance (you pay a small % of out of pocket, often 10% or 20%), and spending after the out-of-pocket maximum is reached (0% out of pocket).  This is quite confusing, at first.

  Generally, employees will have the option of a few different health insurance plans.  Most employees will have at least one option that operates as discussed above.  Commonly, one option will be a high deductible plan.  A high deductible plan has low premiums (good), but a high deductible (bad).  A person using a high deductible plan keeps their monthly costs low but will be required to spend a lot of money out of pocket if they have significant medical expenses.  This plan is almost always the best option for folks that are healthy and thus have low medical expenses, but even people with high medical costs are often wise to select a high deductible plan.  This is especially true for individuals willing to max-out their HSA plan, which is only available under a high deductible plan.  Because maxing-out an HSA leads to significant tax savings, the high deductible plan may be superior to other options for everyone. But don’t take my word for it.  Health insurance plans vary significantly from employer to employer and by medical provider.  To choose the plan that is best for you, you’ll need to do some research and investigate the merits of each plan.  (This is a serious pain in the buttocks.)

  As a second option, most folks can choose a similar plan with higher premiums, but a lower deductible.  There’s no industry-preferred term for such a plan, but many insurers call it a comprehensive plan.  There’s not too much to discuss here.  A comprehensive plan is more expensive to maintain (high premiums), but your insurer will cover medical costs more quickly if you have a lot of expenses (lower deductible).  Additionally, these plans have a lower out-of-pocket maximum than high deductible plans.  While it may seem like such policies are ideal for people with a lot of medical costs, the cost of extra premiums often negates the benefit of a lower deductible and reduced out-of-pocket maximums.  But again, you will need to investigate your options before choosing a plan.

  In addition to the above plans, you may be offered the option of a Health Maintenance Organization (HMO), which is quite different from those discussed above.  This plan typically requires the insured to make medical appointments directly through a primary care physician.  As a comparison, imagine you have a foot issue that makes it difficult to walk.  Under a high deductible plan, you might visit a podiatrist and pay for the visit out-of-pocket (or, if you’ve reached your deductible, share the cost with your provider).  Under an HMO, however, you would first visit your primary care physician who would treat your or refer you to a podiatrist that is within the same medical network.[7]  While HMOs normally have high premiums, trips to your primary doctor are quite cheap (for you).  For example, you may incur a $40 fee for every visit to your physician—this small charge is called a copay.  Many HMOs have a very low deductible or no deductible at all.  As such, your medical costs are shared between you and your insurance provider from the get-go.  Most healthy folks will not select an HMO plan since the premiums are so high and these plans are often poor choices for people that reside outside of cities.  While I’m offered an HMO plan, there is literally no in-network doctor in my county of about 50,000 residents.  So, if were to choose the HMO, I would need to commute to a nearby city for every medical issue.  No bueno.  If I decided to visit a doctor that is out-of-network, it’s possible that my insurer would pay nothing.  No bueno, again. 

  One final plan to mention:  A Preferred Provider Organization (PPO).  These plans usually have the highest premiums of all, so healthy individuals are wise to avoid, if possible.  About one-third of employees only have one health insurance plan offered and PPOs are the most common among for-profit firms.  So, there’s a reasonable chance that your employer will offer a PPO as its sole option.  PPOs are expensive but provide thorough coverage with far more flexibility than an HMO.  Like HMOs, PPO plans incentivize the insured to visit in-network doctors by levying small copays for these medical visits.  However, unlike HMOs, PPO insurers usually pay 50% or more of the cost for out-of-network visits.  So, as a member of a PPO, you are best off visiting an in-network physician, but it’s not a disaster if you need to go out-of-network for whatever reason.

  Keep in mind that there are loads of different plans with their own unique quirks.  So, there’s only so much I can do to help.  If you’re healthy and are offered a high deductible plan, that’s probably the one to choose.  If not, then you’ll really need to investigate your offerings before deciding.  If you are one of the unlucky ones, who is only offered one health insurance plan, you’ll still need to carefully read about the details of your plan.  For married couples, especially those with kids, it’s often best to have only one health insurance plan.  Maybe your for-profit firm offers three plans, and your wife is a government employee with four options.  You and your spouse will probably need to sit down during open enrollment and consider all these options before making a final choice.[8]  This truly sucks.  But over time, it gets easier since you’ll become more knowledgeable of these insurance offerings and your health care needs.

18.4 My Three Insurance Options

            Let’s take a look at my health insurance options, which are typical for a government employee and not too dissimilar to what you might expect to see if you work for a large for-profit firm.  Since I’m guessing many of my readers are un-married and have no kids, let’s first look at the plans available to single individuals. 

While there are loads of complex details to uncover, it’s immediately clear why healthy individuals frequently opt for the high deductible plan.  The high deductible plan’s premiums cost $1,067.28 annually compared to $2,480.16 and $3,038.40 for the comprehensive and HMO plans, respectively.  Additionally, the high deductible plan provides access to an HSA, which includes a 100% match on the first $375 in contributions. 

  For healthy employees, this should be a no-brainer selection, but I’ve discovered that many naively select the comprehensive plan because they want the “good” insurance.  Ugh.  Even if a person has significant health insurance costs, the high deductible plan will frequently be the cheaper option.  In fact, I’ve run various simulations and found that a person maxing-out an HSA will have cheaper annual health care costs than the comprehensive plan in nearly all scenarios.[9] It's even more difficult to compare the high deductible plan to the HMO, but again, the high deductible plan will be preferrable for most, if they are willing to make significant HSA contributions.  Your plans may be quite different.  So, again, be prepared to spend some time reading about the features and nuances of your insurance options.

            What if you have a spouse and/or kids?  Now your options will become even more complex.  Here are the high deductible plans that I am offered by my employer:

I have a wife (who works) and two kids.  Given the plan offerings, our selection is obvious.  We choose the family plan.  Note that this plan effectively gets cheaper the more kids you have.  If we had a third child (lol, no), our monthly premium would not change, so each additional child lowers the average cost of health insurance for each member of our family.  That’s great news if you expect to have a lot of kids.  While the choice is easy for us, that’s not always the case.  When two working individuals get married, choosing plans can be a challenge.  

18.5 Calculations 

Imagine you will soon turn 26 years old and must choose one of the two health insurance plans listed above.  As is always the case, the high deductible plan has lower premiums, a higher deductible, and a higher out-of-pocket maximum.  Once the deductible is reached, the insurer pays 80% of all expenses on the high deductible plan and 90% for the comprehensive plan.  For simplicity, let’s assume that all other features about these two plans are identical. 

Q1:  For the 2025 calendar year, you expect to have $2,000 in medical expenses, which are non-preventative.  How much will each plan cost you, including premiums? 

Let’s start with the high deductible plan.

Health Insurance Premiums = $105*12 = $1,260

Now, consider the direct cost to you of $2,000 in expenses.  These costs are not preventative—these costs are not flu shots or an annual physically—so they are not provided to you free of charge. 

Since you do not reach your deductible, you will pay the $2,000 fully out of pocket.

Medical costs out of pocket = $2,000

Total Costs = $3,260

Now, we will solve for medical expenses for the comprehensive plan.

Health Insurance Premiums = $200*12 = $2,400

Now, consider the direct cost to you of $2,000 in expenses. 

The first $1,500 in expenses will be paid totally out of pocket.  You will pay the 10% of the expense for the next $500 in medical costs.

Medical costs out of pocket = $1,500 + $500(0.1) = $1,550

Total Costs = $3,950

Thus, the high deductible plan is the cheaper option.  Furthermore, this plan offers an HSA, so it is clearly the better option in this simple exercise.

Q2:  For the 2025 calendar year, you expect to have $18,000 in medical expenses, which are non-preventative.  How much will each plan cost you, including premiums? 

Let’s start with the high deductible plan.

Health Insurance Premiums = $105*12 = $1,260

Now, consider the direct cost to you of $18,000 in expenses.  It’s tempting to think that the out-of-pocket maximum will be reached, but that’s not necessarily the case.  This is not $18,000 in medical costs to YOU, it’s $18,000 in medical costs, total.  Of this $1,000, your insurer will pay a substantial share. 

To determine if the out of pocket maximum is reached, solve for the medical costs to you as if the out of pocket maximum doesn’t apply, then check to see if the maximum has been reached.  Like this:

You pay the first $2,000 out of pocket.  You pay 20% on remaining costs.

Medical costs out of pocket = $2,500 + $15,500(0.2) = $5,600 $5,000

In this scenario, you reach your out-of-pocket maximum.  So, $5,000 is your out-of-pocket cost for medical care.  Now, let’s add-in premiums.

Total Costs = $6,260

Now, we will solve for medical expenses for the comprehensive plan.

Health Insurance Premiums = $200*12 = $2,400

Now, consider the direct cost to you of $18,000 in expenses.  The first $1,500 in expenses will be paid totally out of pocket.  You will pay the10% of the expense for the next $16,500 in medical costs.

Medical costs out of pocket = $1,500 + $16,500(0.1) = $3,150

In this scenario, the out-of-pocket maximum is not reached.

Total Costs = $5,550

So, it appears that the comprehensive plan is a better option but remember that the high deductible plan offers an HSA.  If this person can max-out an HSA, the tax savings generated by the HSA contributions will likely cause the high deductible plan to be preferrable.  From my experience, it is quite the challenge to explain this to the financially unsavvy.  

            In the real world, such calculations are imperfect.  There are slight differences between the two plans that make precise calculations infeasible. For example, you might find that primary care visits under the comprehensive plan trigger a small copay.  Or perhaps there are differences in charges that are in-network vs. out-of-network.  When you’re making your initial insurance selection, it’s impossible to predict your future costs.  But, after your first year of insurance, perhaps you can look back at your costs during the previous year and retroactively determine which plan would have been better since your expenses are known.  This will allow you to make a more informed decision during open enrollment for the following year’s insurance.  But to be perfectly frank with you, these exercises are overkill for most young folks.  Choose the high deductible plan (if you have one!), max-out your HSA, and you’ll be happy with your choices.

18.6 Spending Accounts

            Back in Chapter 15, I praised the merits of the health savings account (HSA).  It’s an amazing plan.  Contributions to an HSA avoid all taxes (income, Social Security, Medicare).  Funds held in an HSA can be invested tax-free.  And if a person uses money in their HSA to pay for medical expenses, the money is not taxed upon spending.  So, an HSA allows you to effectively earn and spend money completely tax free.  Wow.  While it’s best to use HSA funds to pay for medical expenses, these funds can be withdrawn for any reason at age 65 (but these withdrawals will trigger income taxes).[10]  In 2025, the maximum contribution to an HSA is $4,300 (single) or $8,550 (employee + spouse, employee + children, or family plan).[11]  Only individuals with a high deductible plan can contribute to an HSA, but one can continue to spend unused HSA money on medical care if they switch to a non-high-deductible plan.

            While the HSA is easily the best spending account, it’s not the only one available.  If you have a non-high-deductible plan, whether it be a comprehensive, HMO, or PPO, you will likely have the option to make contributions to a medical flexible spending account (medical FSA).  While HSAs are available to all individuals with a high deductible plan, medical FSAs are only an option for individuals working for an employee that offers one.  If your employer's selected insurance provided doesn’t offer one or if you are self-employed, you’re out of luck.  Contributions to a medical FSA avoid all taxes, which is great!  But money in an FSA cannot be invested and the funds are use-it-or-lose-it, meaning that the funds cannot be carried over to future years.  If you contribute to a medical FSA in 2025, you have until December 31st to use this money (or perhaps as late as March 15th of 2025 since many insurers offer a grace period for additional spending).[12]  So, the tax savings in a medical FSA are nice, but the plans are otherwise quite crappy.  The types of purchases that can be made with an FSA are (as far as I can tell) the same as what is applicable for HSAs. 

            In 2025, the maximum contribution to a medical FSA is $3,300 per plan.  If you and your spouse have separate insurance plans, then your maximum contributions are $3,300 each ($6,600 total).  But if you are on a combined plan, the maximum contribution is only $3,300 total.  While HSA users can happily max-out their HSA every year, those with a medical FSA need to be careful.  If you max-out your FSA plan but only have $1,000 in annual expenses, you will lose the unspent $2,300. 

            A third spending account that you may find useful is a limited purpose FSA.  These plans are similar to medical FSAs but are only available to individuals who have a high deductible plan and are already enrolled in an HSA.  This plan is use-it-or-lose it and cannot be invested, but they offer valuable tax savings just like the other plans.  The maximum contribution to a limited purpose FSA is $3,300 per insured account in 2025.[13]  Funds in these accounts can only be spent on vision and dental costs.  So, these plans are only important for those that know they will have significant vision and dental expenses.  Remember that you can use HSA funds to pay for dental and vision expenses; thus, you should never contribute to a limited purpose FSA if you are not already maxing out your HSA account.  

            The fourth and final spending account is the dependent care FSA.  This one also allows individuals to make contributions, which completely avoid taxes.  Like the other FSAs, the plan is use-it-or-lose-it and cannot be invested.  Funds in a dependent care FSA can be used to pay for dependent care services like daycare, a nanny, preschool, summer camp, etc.  However, these funds cannot be used to cover k-12 education expenses.  Furthermore, both parents typically need to be working to be permitted to take advantage.[14]  So, a dependent care FSA is most easily used when both parents are working, and they have a child that is aged 0-5.  Additionally, these funds can be used to “care for your spouse a relative who is mentally incapable of self-care and lives in your home”… for example, an in-home caretaker that watches out for your 90-year-old grandmother while you are at work.[15]  The maximum contribution for this plan in 2025 is $2,500 for those that file taxes as single and $5,000 for other filers (married or head of household).  If you qualify, this plan is a no-brainer.  For example, suppose you have a child that goes to daycare, which costs $10,000/year.  By contributing the maximum to your dependent care FSA ($5,000 in most cases), you can skip-out on significant taxes.  While the money cannot be invested, the tax savings are so significant that this downside can be overlooked.[16]

            To minimize your taxes, you’ll need to fully understand the ins-and-outs of the plans you use.  Personally, I max-out my HSA every year and took full advantage of the dependent care FSA when my kids were in daycare.  I could use the limited purpose FSA as well, but don’t think it’s worth the trouble for me.[17]  Here is a table summarizing the plans discussed. 

18.7 Conclusions

            Phew.  This was a long chapter.  And I could go on and on.  But this is a subject area where most of the work falls on you.  I can easily tell you the rules related to Social Security or how a Roth IRA works, but there is too much variation among health insurance plans to provide a one-size-fits-all lesson.  

End Notes

[1] That might sound like an odd way to phrase that sentence, but the average citizen didn’t spend this much.  A substantial portion of US medical spending is paid by the federal government, non-profits, and other entities.

[2] Source.

[3] If you are self-employed or work for a firm that doesn’t offer health insurance (usually a tiny business), then you will need to buy private life insurance, which is more expensive than employer sponsored plans.  If you buy private insurance, the cost of premiums and contributions to HSA avoid income taxes, but do not avoid Social Security or Medicare taxes

[4] For example, a Georgia resident making $100,000 pays a total marginal tax rate of 35.4%.  So a $150 health insurance premium only costs $96.90 once the tax savings are considered.

[5]  But I can make changes to spending accounts.  For example, I can increase or decrease my monthly HSA contributions.

[6] Source.

[7] Basically the insurance firms have contracts or agreements with some, but not all medical professionals.  Those that are connected to the insurance firm are in-network. Those that aren’t are out-of-network.  If you go to a doctor that is in-network, the insurance firm and the physician have already agreed upon pricing.  If you visit an out-of-network doctor, the insurer has no contract with said doctor and thusly will not pay for your care (or at least not pay much). 

[8] You could stand up if you want, but your legs will get tired.

[9] Because the specific details of these plans are complicated and are specific to me, I’m choosing not to show these mathematical comparisons here.

[10] At worse, an HSA is a like a superior version of a traditional 401(k).  While traditional 401(k) contributions avoid income taxes, HSA contributions skip income taxes, Social Security taxes, and Medicare taxes.  So, HSAs are better than 401(k) plans even if you don’t use the money to pay for medical expenses.

[11] The maximum contribution for a married couple is $8,5500 in total.  So, if you have a health insurance plan with your kids and your spouse has an individual plan, you are not permitted to contribute more than $8,550 combined.

[12] Employers have the option to allow up to $640 to be rolled-over to next year’s fund.  So, it’s possible that the entire value of a medical FSA will not be use-it-or-lose-it.

[13] Like the medical FSA, this is a limit per insurance account, not per person.  If you have your spouse have separate plans, you can contribute $3,300 each.  If you’re one a combined account, your maximum contribution is $3,300 total.

[14] If a parent is not working, the government doesn’t believe you should get a tax break for sending your kids off to daycare.  Note that "both parents" is not relevant in cases where there is one caretaker (e.g. a "single parent" with sole custody).  If a single parent works, he or she is eligible to use a Dependent Care FSA.

[15] Source for quote.

[16] Also, the money in this account doesn’t need to sit for long.  With proper planning, you can spend a new dependent care FSA contribution very quickly.

[17] We don’t have significant vision and dental costs.  So, maybe we have $300 in such expenses in a year.  We use our HSA to cover these costs, so we are paying for these expenses tax free even without using the limited purpose FSA.   

Key Terms

Coinsurance:  Spending scenario where you and your insurer share the burden of medical costs.  For example, an 80% coinsurance rate means that your insurer will pay 80% of the cost for a medical procedure and you will pay 20% out-of-pocket.  Under high deductible and comprehensive plans, a coinsurance period is reached only after a deductible is met.

Copay:  A small out-of-pocket charge for a routine medical cost.  For example, a visit to a primary care physician result in a small copay of $20 to $50 for a member of an HMO or PPOs.  Comprehensive plans also may have copays.

Deductible:  How much you must pay (in addition to premiums) before your health insurance provider will begin paying for most of all of your additional expenses.  High deductible and comprehensive plans always have a deductible, HMOs and PPOs sometimes do.  Example:  I must pay $4,400 out-of-pocket before I “hit my deductible”.  Once I’ve reached my deductible, my insurer will cover most of my expenses.

Dependent Care FSA:  Offers the same tax savings as other FSAs but can only be spent on dependent care services, like day care expenses.  It’s use-it-or-lose-it and does not allow for investing.

Health Insurance:  Read the chapter, you bum.           

Health Maintenance Organization:  Plan with high premiums and copays for many medical costs.  These plans often require the insured to seek medical care via a primary care physician, who will refer patients to in-network specialists if needed.  HMO insurers provide little to no financially help for out-of-network medical costs.

High Deductible Plan:  Health insurance plan with low premiums and a high deductible.  For healthy folks, this is usually the best choice.  Only those with a high deductible plan can contribute to an HAS

In-Network:  Your insurer has a contract with the medical provider; the insurer and healthcare provider have agreed upon prices for common medical treatments.  While “networks” can matter for many plans, they are most important for HMOs and PPOs.  For these plans, in-network medical care will be far cheaper for the insured, compared to out-of-network.  If you have a HMO or PPO, you should seek medical providers that are in-network.  Call up the healthcare provider (and/or your insurer) before seeking medical care to make sure that you are “in-network”.

Life Insurance:  A form of life insurance that pays out your beneficiaries if you die.  There are loads of different life insurance policies with various rules and regulations. 

Limited Purpose FSA:  Offers the same tax savings as other FSAs but can only be spent on dental and vision expenses.  It’s use-it-or-lose-it and does not allow for investing.

Medical FSA:  Similar to an HSA, but the funds cannot be invested and are use-it-or-lose it.  Available to those that have a non-high-deductible plan, but only if this account is provided by the employer.

Open Enrollment Period:  A window of time in which folks make their health insurance elections for the following calendar year.  After open enrollment, it’s usually impossible to adjust one’s health insurance policies.

Out-of-Network:  Not in-network (see “in-network” above for more info)

Out-of-Pocket:  The dollar amount that you must pay yourself for a given medical cost.  For example, if your insurer pays$1,800 for a $2,000 medical bill, you only pay $200 out-of-pocket.

Out-of-Pocket Maximum:  The maximum out of pocket expense that an insured person can have in a given year.  For example, a person with an $8,000 out-of-pocket maximum will only spend $8,000 in medical costs in a given year even if they have millions-of-dollars in expenses.  (Or at least that’s the idea. There are horror stories of insured firms refusing to pay for medical care that they deem to be unnecessary.)

Preferred Provider Organization:  Health insurance plan with very high premiums.  These plans usually allow the insured to seek medical care with little direct cost.  The insurer is especially generous with in-network medical costs, but will also kick-in for out-of-network expenses.

Premiums:  Mandatory charges for health insurance, usually applied monthly.  Example:  I pay $314.76/month in premiums for my family’s health insurance plan that is offered by my employer

Preventative Care:  Medical costs that the insurance company will fully cover, under the assumption that these expenses will keep you healthy and reduce your yearly medical costs (which is good for the insurance company). 

Qualifying Life Event:  Health insurance plans can typically only be changed during open enrollment.  There are exceptions which allow the insured to change their plan at any time of year; these are called qualifying life events.  For example, if you have a child, you are permitted to switch health insurance plans or alter specifics of your coverage.

Use-it-or-lose-it:  Not a technical term but is frequently used to describe spending accounts that have an expiration point.  All FSAs are use-it-or-lose-it, if you don’t spend the money in the account by a certain date (often March 15th), the money disappears from your account.  HSA accounts are not use-it-or-lose-it.

Practice Problems

*Answer tax-related questions as if there are no deductions available*

1. In general, for a single individual in good health, which plan will be the best:  A high deductible plan, a comprehensive plan, or a HMO?  Explain your logic.

The high deductible plan.  While this plan has a high deductible and a high out-of-pocket maximum, it also has the lowest premiums.  For a healthy person that expects their medical costs to be low, this plan will ultimately be the cheapest.  Also, it’s the only plan to provides access to an HSA. 

2. Grayson earns $70,000 per year.  He contributes $3,000 to a traditional 401k, $2,000 to an HSA, $300 to a limited purpose FSA, and $1,500 to a dependent care FSA. 

a.       How much taxable income does he have, from a federal income tax perspective?

Taxable Income = $70,000 - $3,000 - $2,000 - $300 - $1,500 = $63,200

Income Taxes = $8,818

b.      How much will he pay in social security taxes this year?

SS Income = $70,000 - $2,000 - $300 - $1,500 = $66,200

SS Taxes = $66,200(.062) = $4,104.40

c.       How much will he pay in Medicare taxes this year?

Medicare Income = $70,000 - $2,000 - $300 - $1,500 = $66,200

Medicare Taxes = $66,200(.0145) = $959.90

d.      What can he use the dependent care FSA for?

Paying for dependent care expenses like daycare expenses, summer school, or a nanny.  Things like that (as long as he is working and has primary custody of a child).  Or, if he has someone old/disabled living at his house as a dependent, he may be able to use that money to pay for in-house care.

e.       What can he use the limited purpose FSA for?

Vision and dental expenses only.

f.         Do you have any recommendations for Grayson in regards to his choices?  (There is one obvious mistake)

He is contributing to a limited purpose FSA but not maxing-out his HSA.  This is dumb.  An HSA and limited purpose FSA offer the same tax benefits, but an HSA can be invested, is not use-it-or-lose-it and can be spent on any medical cost.  The $300 in his limited purpose FSA should have been contribute to his HSA.

3. How do insurance companies discourage you from using out-of-network providers?

Under most plans (especially non-high-deductible), the insurer will pay a larger share of a medical expense when you visit an in-network provider. 

Use the following information to answer questions 4-7

Your health insurance plan has the following features.  Assume for simplicity that you will only make in-network purchases, so we can ignore the out-of-network details.  Also, assume that all purchases made are the “covered, but not free” variety.

Premium = $105/month

Deductible = $1,000

Out-of-pocket maximum = $3,500

For this plan, you will pay 25% of all expenses once your deductible is met, before your out-of pocket maximum is reached.  (As with all plans, you will pay 100% of expenses before your deducible is met and 0% after your out-of-pocket maximum is met).

4. You have $1,100 in annual medical expenses.  Including your health insurance premiums, how much do you spend on all medical care this year?

Premiums = $105*12 = $1,260

OOP Spending = $1,000 + $100*0.25 = $1,025

Total Spending = $2,285

5. You have $4,500 in annual medical expenses.  Including your health insurance premiums, how much do you spend on all medical care this year?

Premiums = $105*12 = $1,260

OOP Spending = $1,000 + $3,500*0.25 = $1,875

Total Spending = $3,135

6. You have $12,800 in annual medical expenses.  Including your health insurance premiums, how much do you spend on all medical care this year?

Premiums = $105*12 = $1,260

OOP Spending = $1,000 + $11,800*0.25 = $3,950 $3,500

^^^The out-of-pocket-max is reached

Total Spending = $4,760

7. You have $81,000 in annual medical expenses.  Including your health insurance premiums, how much do you spend on all medical care this year?

Total Spending = $4,760

The OOP max is reached.  So this is the same answer as question 6.

Use the following information to answer questions 8-11.

Your health insurance plan has the following features.  Assume for simplicity that you will only make in-network purchases, so we can ignore the out-of-network details.  Also, assume that all purchases made are the “covered, but not free” variety.

Premium = $280/month

Deductible = $500

Out-of-pocket maximum = $2,000

For this plan, you will pay 10% of all expenses once your deductible is met, before your out-of pocket maximum is reached.  (As with all plans, you will pay 100% of expenses before your deducible is met and 0% after your out-of-pocket maximum is met).

8. You have $300 in annual medical expenses.  Including your health insurance premiums, how much do you spend on all medical care this year?

Premiums = $280*12 = $3,360

OOP Spending = $300

Total Spending = $3,660

9. You have $3,500 in annual medical expenses.  Including your health insurance premiums, how much do you spend on all medical care this year?

Premiums = $280*12 = $3,360

OOP Spending = $500 + $3,000(0.1) = $800

Total Spending = $4,160

10. You have $8,900 in annual medical expenses.  Including your health insurance premiums, how much do you spend on all medical care this year?

Premiums = $280*12 = $3,360

OOP Spending = $500 + $8,400(0.1) = $1,340

Total Spending = $4,700

11. How much would your total medical costs need to be to reach your OOP maximum?

$2,000 = $500 + X(0.1)

X = $15,000 à This is the total spending after reaching your deductible.  So, we need to add $500 to this.

Medical Costs = $15,500

12. Explain why a person with no kids probably doesn’t need life insurance.

Insurance covers you in the case of death when your income is needed by someone else.  If you have no kids, you probably don’t have someone else depending on your income.  So, life insurance is not a necessity. 

13. Bailey has $250 in her limited use FSA and $18,600 in her HSA.  She has a $300 dental bill she needs to pay.  How should she pay for it?

She should completely use up her limited purpose FSA.  Why?  It is use-it-of-lose it and is not invested, so she’s better off spending this money first.  So, she should spend $250 from her limited purpose FSA and then the remaining $50 should be paid by her HSA. 

14. Greg and Mindy are married.  Greg is an attorney and Mindy is a stay-at-home parent.  Every Friday, Mindy plays tennis with her friends for about 2 hours.  They would like to hire a nanny to watch the kids during these two hours, which would cost $80/week.  Can they pay for this using a dependent care FSA?

No.  To be eligible, both parents need to be working. Dependent Care FSAs are designed to give parents a tax break when both work but need to pay childcare expenses.

15. Jason and Eliza are married.  They have a joint HMO plan (employee +spouse).  How much can they contribute to a medical FSA if their employer offers one?

$3,300.

16. Lauren and Mandy are married.  They each have a PPO plan (two separate plans).  How much can they contribute to medical FSAs if their employers each offer one?

$6,600 total.  They can each have a plan.

17. Ian and Emma are married and have four kids.  Ian has a high deductible plan that includes the kids.  Emma is on a separate plan high deductible plan.  How much can they contribute to an HSA?

$8,300 total.  It’s likely that they have two options.  Emma could contribute, at most, $4,150 to her plan (if she does so, then Ian can only contribute $4,150 to his).  Or, Ian could contribute as much as $8,300 to his (in which case, Emma cannot contribute at all to hers).  It’s important to recognize that Emma cannot use her HSA to pay for medical costs for Ian and the kids, nor can Ian use his plan to pay for Emma.  So, it’s advisable that they prioritize Ian’s plan, since he will face more medical costs.

This might seem like a strange scenario, but such circumstances are not uncommon.  Emma may work for an employer that provides free health insurance while Ian works for a firm that offers a very good employee + children plan. 

18. Ian and Emma are married and have four kids; both work full-time.  Their insurance plans offer access to a dependent care FSA.  Two of the kids attend an expensive daycare.  So, they decide to contribute $10,000 in total to dependent care FSA plans.  How much will this save them in taxes?  Assume they live in Florida (no income taxes) and are in the 24% marginal tax rate for US income taxes.

Contributions to a dependent care FSA avoid federal income taxes, Social Security taxes, and Medicare taxes.  So, they will avoid taxes at the 24%, 6.2%, and 1.45% rates, respectively.  Collectively, this means that they avoid a 31.65% tax on each dollar contributed.  Their $10,000 contribution avoid $3,165 in taxes.  Nice!