Your Next Healthy Habit: The HSA

One of the top 10 questions I get from clients is should I open an HSA (Health Savings Account)? It is open enrollment season and HSAs have risen in popularity over the last few years, so let me take the opportunity to address the question here.

First, what are HSAs?

HSAs are personal savings accounts that can only be used for qualified health care expenses and out-of-pocket costs not covered by health plans. They offer tax benefits, spending flexibility, and portability.

Second, who is eligible?

To contribute to an HSA, you must be enrolled in a qualifying high-deductible health plan (HDHP). For 2022 the HDHP for individuals must have a deductible of at least $1,400 and an out-of-pocket medical expense limit of $7,050, and the HDHP for families must have a deductible of at least $2,800 and an out-of-pocket medical expense limit of $14,100.

Third, how do I get one?

You can enroll in an HDHP and an HSA through your employer if available, or find an HDHP on the health insurance marketplace and an HSA through a financial institution.

Here is a summary of the advantages and disadvantages of HSAs:

Advantages:

  • If you make contributions with pre-tax dollars, they are excluded from your gross income.
  • If you make contributions with after-tax dollars, you can deduct them from your gross income on your tax return.
  • Contributions can earn interest and be invested.
  • Your investments can grow and compound on a tax-deferred basis, which means there are no capital gains taxes on earnings.
  • Withdrawals are tax-free for qualified health care expenses.
  • You don’t have to make withdrawals in the year that the expenses are incurred (just save the receipts for the year in which you do make the withdrawals).
  • Any unused money at the end of the year rolls over to the next year (unlike Flexible Spending Accounts (FSAs)).
  • The account is always owned by you even if you change employers or terminate employment.
  • When HSA money is used to pay for health care costs in retirement, it has more buying power than money from retirement plans like 401ks where you will owe income taxes on withdrawals.

Disadvantages:

  • It can be challenging to budget how much to save as medical expenses are often unpredictable.
  • HSAs have low contribution limits – the 2022 contribution limit is $3,650/year for individuals with additional catch-up contributions of $1,000 between ages 55 and 65. (This amount is reduced by any employer contributions excluded from gross income.)
  • Once you enroll in Medicare at age 65 you can no longer contribute.
  • If you withdraw funds for nonmedical expenses before age 65, you will have to pay income taxes on the money and an additional 20% penalty. If you withdraw funds for nonmedical expenses after age 65, you don’t have to pay a penalty but you will have to pay income taxes on the money.

For an HSA to be worth it, you should be relatively healthy and good with recordkeeping. If this describes you, consider adding HSAs to your financial to-do list. “I don’t like tax savings” said no one ever.

Life Insurance for Lollygaggers

Life insurance is not a topic that the vast majority of people want to think about, but it’s an essential piece of the financial planning puzzle. Purchasing a life insurance policy can significantly ease the way for your heirs. While there are umpteen types of life insurance products on the market, there is generally only one kind that I advocate, where you are not being sold something with bells and whistles that you don’t need, and that is a term life insurance policy.

What is term life insurance? Term life insurance is exactly what it sounds like, a policy that you purchase for a certain period of time, commonly 10, 15, 20 or 30 years. There are several types of term – for example where the premiums start low but increase annually (annual renewable term) or where you pay higher premiums for the chance of outliving your policy and being refunded some of the premiums at the end of the term (return premium term). But the type that I’ve found to be most appropriate for most people is level premium term, where the premiums are fixed over the life of the policy. When any of these terms expire, the policyholder can restart coverage at a higher rate or give up coverage altogether. In essence, you are renting a life insurance policy instead of owning it, meaning there are no accumulated cash benefits that need to be paid out at the end of the term.

Life insurance policies that do have the benefit of a guaranteed payout are called permanent life insurance, and this is like being a homeowner instead of a renter. Permanent life insurance comes in several basic types, whole life, universal life, and variable universal life, and all build up a cash value and last for your lifetime.

On first glance permanent life insurance sure sounds better than term life insurance. Why rent when you can build equity as an owner? Well, permanent life insurance definitely has a place in complex estate plans or charitable giving strategies, but for most of the population, term is the best option. This is because term is by far the least expensive option as you get the most death benefit per dollar paid. While term does not bank your cash in an investment account, the money that you are not spending on more expensive permanent life insurance premiums can be invested more competitively, which means you should expect higher returns. Furthermore, in most cases I think of life insurance as an income replacement strategy, and so I advise clients to match their term policies as closely as possible to their retirement dates. Once their income turns off, so does their life insurance policy. As that point, clients should have pension, portfolio, or other supplemental income to provide for their needs comfortably in retirement.

For people with children and/or mortgages, term life insurance is a necessary consideration. To throw out some ballpark numbers – if you are in your late 30s or early 40s you should be able to get a policy for between $10-80 a month that will give you between $100,000 and $1 million in coverage. That’s a small price to pay for a big relief should the need arise.

DIY Retirement Savings: SEP IRAs vs. Individual 401(k)s

Are you a free spirit not beholden to a boss who would like to sock away money for retirement in a tax-deferred savings plan that has higher limits than Traditional and Roth IRAs? This blog post is for you. Two fantastic options are the Simplified Employee Pension (SEP) IRA and the Individual 401(k) (aka the Self-Employed 401(k) or the Solo 401(k)). Both of these plans are easy to set up and administer, have high contribution limits, and offer funding flexibility.

The rundown on SEP IRAs:

  • Easy to open: SEPs are offered at most financial institutions that offer retirement accounts.
  • Funding: only by employers, not allowed by employees.
  • Funding flexibility: No minimum annual contribution amount. In flush years you can contribute more, in tough times you can scale back.
  • Contribution limits: You can contribute as much as 25% of your compensation (generally 20% if you’re self-employed[1]), up to $56,000 for 2019.
  • Eligibility: Almost any type of business can offer a SEP. It is best for self-employed individuals and small business owners. An employee is eligible to participate if they are at least age 21, worked for the company in 3 of the last 5 years, and received at least $600 in compensation during the year.
  • If you set up a SEP for yourself, you have to set one up for each eligible employee.
  • If you contribute to your own SEP, you have to contribute the same percentage to each eligible employee’s SEP.
  • Tax benefits: Tax-deferred contributions and investment growth, tax-deductible contributions.
  • Loans: Not allowed.
  • Vesting: Immediate.
  • Administrative considerations: No additional IRS reporting.

The rundown on Individual 401(k)s:

  • Easy to open: Individual 401(k)s are offered at most financial institutions that offer retirement accounts.
  • Funding: only by business owners, in dual role of employer and employee.
  • Funding flexibility: No minimum annual contribution amount. In flush years you can contribute more, in tough times you can scale back.
  • Contribution limits: You can put away more money than with a SEP. This is because you can contribute both as an employee and an employer. As an employee, you can contribute $19,000 ($25,000 if you’re age 50 or older). As an employer, you can contribute an additional 25% of compensation (generally 20% if you’re self-employed), up to a maximum of $56,000 ($62,000 if you’re age 50 or older) for 2019.
  • Eligibility: Business owners who have no employees. This includes sole proprietors, LLCs, S and C corporations, partnerships, and tax-exempt organizations. You must have at least a 5% share in the business. Spouses can contribute if they earn income from the business.
  • Tax benefits: Tax-deferred contributions and investment growth, tax-deductible contributions.
  • Loans: Allowed, but depends on the plan administrator. Generally you can borrow 50% of the account balance, up to $50,000, and take up to 5 years to pay it back.
  • Vesting: Immediate.
  • Administrative considerations: Once your balance reaches $250,000, you have to submit IRS Form 5500 every year.

Both plans allow you to accumulate a formidable nest egg without being subject to the tax consequences of regular brokerage accounts or the low contribution limits of Traditional and Roth IRAs. Start early with smaller amounts and let the magic of compounding interest go to work for you. Or, start later and contribute the maximum possible – with such high contribution limits these plans are perfect for catching up.


[1] Business net profit from your IRS Schedule C, after subtracting out the self-employment tax deduction.

The Next Generation of Reverse Mortgages

When used appropriately, a reverse mortgage can be an effective tool for managing retirement income. If you are not planning to bequeath your home to beneficiaries, a reverse mortgage can provide an income stream to supplement your cash flow and protect your portfolio during market downturns. In the 80s and 90s, reverse mortgages were often used as a last resort and had a bad reputation due to high fees, overly complex arrangements, and scams. But fast forward to the current day where reverse mortgages are better regulated and insured, and rules are in place to prevent these kinds of abuses. For a senior whose wealth is tied up in an illiquid asset such as their home and who has insufficient income streams to provide a comfortable retirement, then a reverse mortgage could be a great choice.

What is a reverse mortgage? Basically, a reverse mortgage is the opposite of a conventional mortgage. Instead of turning the principal portion of your mortgage payment into home equity, you turn your home equity into money that you can use. A reverse mortgage allows you to borrow against your home equity and receive the proceeds in several ways: a lump sum payment, fixed monthly payments for as long as you live in the home (known as a tenure plan), fixed monthly payments for a term of your choosing (known as a term plan), or a line of credit. You can also combine one of the fixed monthly payment options with the line of credit. The loan balance is due when you die, move permanently, or sell the home.

How does it work? The lender makes a payment or payments to you, and you agree to pay the lender back with the equity you have in your home after you leave the home. Of course, you pay interest on the proceeds, but that interest is rolled into the loan balance. The upshot is as long as you are living in your home, you don’t have to pay anything back. You do continue to be responsible for property taxes, insurance, and home maintenance while receiving the proceeds. This is because you remain the owner, and keep the title to your home. Overall, the reverse mortgage increases your debt and decreases your equity.

An attractive feature of a reverse mortgage is that when it’s time to pay the loan back, you never owe more than the value of your home. If the amount you owe is greater than the value of your home, for example if home prices fall or you live longer than expected, your other assets are protected. In this scenario, the lender is reimbursed by the Federal Housing Administration (FHA) mortgage insurance program that you pay into over the life of the loan. If the amount you owe is less than the value of your home, you or your heirs keep the difference.

Here are the eligibility requirements:

  • 62 years of age or older
  • Own your home outright, or be able to pay off the remainder of your mortgage with the proceeds of the reverse mortgage
  • Occupy your home as a principal residence
  • Must be a single-family home, a two-to-four-unit home where you occupy one unit, a U.S. Department of Housing and Urban Development (HUD)-approved condominium, or a manufactured home that meets FHA requirements
  • Mandatory financial counseling to make sure you understand the risks and process of taking out a reverse mortgage

If you meet the aforementioned criteria and are weighing the pros and cons of various income streams for retirement, it may be worth adding a reverse mortgage to your assortment of options.

The Medicare Roundup

Medicare is a federal health insurance program that was established in the 1960s for individuals age 65 or older and for individuals under age 65 with kidney failure, ALS or certain other disabilities. It is funded by the taxes that workers pay to Social Security and Medicare, by the premiums that Medicare beneficiaries pay for their coverage, and by the federal budget.

Medicare has four parts: A, B, C and D. Part A and Part B are considered Original Medicare as they are provided directly through the federal government and Part C and Part D are not considered Original Medicare as they are not provided directly by the federal government.

Part A covers hospital insurance. This includes inpatient hospital care, skilled nursing, hospice care and home health services. This does not include long-term care. You don’t have to pay a premium for Part A coverage as long as you, your spouse, or your ex-spouse worked full time for at least 40 calendar quarters (10 years) and paid Social Security taxes, or if you, your spouse, or your ex-spouse are eligible for Railroad Retirement or Civil Service benefits. You do have to pay a premium if you worked and paid Social Security taxes for less time. If you qualify through your spouse or ex-spouse, you need to have been married for at least 10 years. Most Medicare beneficiaries qualify for this premium-free coverage.

Part B covers medical insurance. This includes outpatient medical care such as doctor visits, tests, preventative care, mental health care, medical equipment like wheelchairs and walkers, and some ambulance and home health services. You have to pay a premium for Part B coverage to the Social Security Administration. If you’re already receiving Social Security, the premiums are deducted from your Social Security benefit, otherwise Social Security bills you directly. The premium starts at a standard amount and increases for people with higher incomes. Each year the premium increases but current Medicare beneficiaries whose premiums are deducted from their Social Security benefit generally avoid the increase due to a hold harmless provision.

Part C is something of a misnomer as it doesn’t refer to a subsection of medical care like the other Parts. Instead, Part C refers to Medicare Advantage Plans, which are plans offered by private companies that have contracted with Medicare. Medicare Advantage Plans are required to provide all Part A and Part B benefits, but can do so with different rules, costs and restrictions. For example, with Medicare you can go to almost any hospital or doctor’s office whereas with Medicare Advantage Plans you can be limited to network providers. Many Medicare Advantage Plans replace Part A, Part B, Part D and Medigap coverages (more on Part D and Medigap below), as well as offering coverage for vision, dental and hearing services. You pay an additional premium for these plans on top of your Part B premium (and your Part A premium if you have one).

Part D covers prescription drugs and is offered by private companies. You can get Part D as a stand-alone private drug plan (known as a PDP) or as a part of a Medicare Advantage Plan with drug coverage (known as a MAPD). However, neither Medicare nor Medicare Advantage Plans cover prescription drug copayments or deductibles. As with Part B, the premium increases for people with higher incomes.

Medigap is supplemental insurance coverage offered by private companies that is designed to fill the gaps in expenses not covered by Medicare. Medigap covers Part A and Part B copayments, coinsurances and deductibles.

Depending on if you are employed or retired, there are different timelines for enrolling in Part A and Part B. However, once you are enrolled in Part A and Part B, there are several paths to getting enough coverage to address your long-term medical needs. If you just enroll in Part A and Part B, you would likely incur substantial out-of-pocket costs. To avoid this, you can enroll in Part A and Part B and supplement these benefits with Part D and/or Medigap coverages. Or if you have employer, retiree, or Veterans’ Administration (VA) medical benefits available to you, these programs can help defray costs. Or you can follow in the footsteps of 1/3 of Medicare beneficiaries and get your benefits through a Medicare Advantage Plan.