We continue our look into retirement funding issues. While we generally think of retirement savings in preparing for retirement, we must also think of healthcare. Healthcare expenses in retirement can be devastating, especially since retirement incomes typically cannot be bumped up to replenish savings consumed by healthcare expenses. As we have discussed issues with personal retirement saving plans , we now discuss personal healthcare savings.
Healthcare is a major expense for many Americans. For Americans with insurance, many have seen premiums skyrocket, along with deductibles, since the passage of the Affordable Care Act. The insured are arguably paying more for effectively less coverage. The reasons for this are beyond the scope of this article. To compound the problem, prices of healthcare often are rising faster than the general rate of inflation. Individuals bear the burden of these changes, paying more and more for medical costs.
As with our previous discussion of retirement savings account, we provide only an overview here. We do not discuss all details of all plans. The information in this article should be seen as general information only, not recommendations for any particular person’s situation.
Personal Healthcare Savings Accounts
Even if medical costs stabilize, medical needs will continue to be a significant expense for many Americans. Just as government has created tax-advantaged accounts for retirement savings, government has created accounts to provide for personal healthcare savings.
Health Savings Accounts (HSA)
Health Savings Accounts were created by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. A person must have an eligible High Deductible Health Plan (HDHP) to contribute to an HSA. He must also have no other health insurance plan, not be on Medicare, and not be a dependent on someone else’s federal income tax return.
An HDHP is a health insurance plan that has a high deductible. Someone healthy may prefer an HDHP in exchange for somewhat reduced premiums. For 2025, an HDHP must have a deductible of at least $1,650 for individual coverage, or $3,300 for family coverage. The maximum out of pocket expense for an individual coverage HDHP is $8,300 ($16,600 for family coverage).
Someone who qualifies may deposit up to $4,300 for individual coverage ($8,550 for family coverage) in an HDHP. Some plan administrators require that a minimum amount of the account must be held in cash, but in general, funds in an HSA may be invested in mutual funds and similar investments.
Some employers who offer HDHPs to their employees set up HSA accounts for them. They may even contribute to the accounts. Employer contributions count against the contribution limits. Whether or not an employer sets up the account, the HSA is the property of the employee and remains with the employee when she leaves the employer.
Deposits into an HSA are tax deductible. If used for allowed medical expenses, withdrawals are not taxed. HSAs are the most tax-advantaged account in the tax code: deposits are deductible, growth is tax free, and allowed withdrawals are tax free. If the owner withdraws funds for non-medical purposes, they are taxed as regular income, plus a 20% penalty. The 20% penalty no longer applies after the account holder reaches the age of 65.
Medicare Medical Savings Accounts (MSA)
Like HSAs, MSAs are designed to allow people to save for medical expenses. There are some key differences.
To qualify for an MSA, the person must be enrolled in Medicare and have a High Deductible Medicare Advantage Plan. These High Deductible plans do not include drug coverage, so anyone wanting to use an MSA would need to purchase a separate Part D Medicare plan, or pay all drug costs fully out of pocket.
Unlike HSAs which have the covered person contribute to the account, Medicare directly contributes to the account. The amount Medicare contributes to the MSA depends on the specific plan that is purchased. MSA account holders may have the option of investing funds.
Funds withdrawn from MSAs must be used to pay for medical expenses. If they are used for other purposes, the withdrawal is taxed as regular income, plus a 50% penalty.
Flexible Spending Accounts (FSA)
Flexible Spending Accounts were created in 1978. There are FSAs for healthcare expenses and FSAs for childcare expenses. Though they are similar, we are concerned only with healthcare FSAs.
Flexible Spending Accounts are offered through an employer. At the beginning of the employer’s benefit year, employees may choose to have some of their paycheck deducted and set aside into a Flexible Spending Account. These are pre-tax deductions, and the benefit of FSAs is the ability to use pre-tax dollars for medical expenses.
The employee determines a fixed amount, maybe $1,300, that will be set aside. In general, that amount cannot be changed by the employee once the amount has been determined. Throughout the year, deductions are made to feed the account. Assuming a biweekly pay schedule and a $1,300 election, the employer would deduct $50 per paycheck and put it in the FSA. In 2025, the law sets a maximum election amount of $3,300.
Employees can then get reimbursed by the FSA for medical expenses. Only documented medical expenses are eligible for reimbursement.
Since the employee has committed to deposit a fixed amount in the FSA, reimbursements can be made against future contributions. For example, an employee elects to contribute $3,300 in 2025. In February 2025, the employee has a large medical expense of $2,000. The employee can be reimbursed from the FSA for that amount, even though she has not yet contributed $2,000.
Unlike the savings plans previously discussed, FSAs are not owned by the employee. At the end of the year, whatever funds remain in the FSA are lost and go back to the employer or plan administrator. Plans may offer grace periods of up to 2½ months past the end of the year to use funds.
Health Reimbursement Arrangements (HRA)
Health Reimbursement Arrangements were first recognized by the IRS with administrative rulings in 2002 which also served to define HRAsm. For decades prior to that, some employers had offered various types of health care reimbursement benefits.
Traditional HRA
There are several varieties of HRA, and we will touch on a few of them here. All HRAs are funded by an employer. The basic idea is that an employer designates a certain amount that they will reimburse employees for eligible medical expenses. Eligible medical expenses are those allowed by both the tax code and the employer’s plan. The employer is not obligated to cover every expense in an HRA that would be allowable under the IRS definition of eligible medical expenses.
As an example of how an HRA could work, an employer creates an HRA with a $12,000 annual cap. An employee could submit requests for reimbursement throughout the year until he has used all $12,000. At the end of the year, funds may roll over or may be forfeited, depending on the plan.
Individual Coverage HRA (ICHRA)
One special form on an HRA is the ICHRA. An ICHRA allows health insurance premiums to be paid from HSA funds, provided the employee has qualifying health insurance. An employer would use this in lieu of providing a group health policy.
Advantages of ICHRAs are increased employee choice in healthcare plans and predictable costs for the employer. Disadvantages are limitations imposed on using other accounts such as HSAs and the generally higher cost and deductibles of individual health plans versus group plans.
Premium Only Individual Coverage HRA
A refinement of the ICHRA is the premium only ICHRA. With a premium-only ICHRA, only health insurance premiums are reimbursable. Other medical expenses cannot be reimbursed by the plan. An advantage to this option is that a premium-only ICHRA can be used with an HSA, whereas HSA contributions are prohibited for people covered by the broader ICHRA. Premium-only ICHRAs could be advantageous for people who want to contribute to an HSA, especially if the ICHRA amount provided by the employer is primarily or completely consumed by insurance premiums.
Problems with the Current Structure
As we have previously discussed with retirement accounts, there are significant issues with the collection of personal healthcare savings plans currently available.
Portability and Accumulation
While HSAs belong to the account holder and are portable, HRAs and FSAs are not. HRAs and FSAs also do not allow long-term accumulation for unexpected major expenses in the future. They may be useful for tax-advantaged spending for relatively predictable expenses, but not catastrophic ones. It is the large, potentially catastrophic ones that can really do financial harm to an individual.
Fairness
Many of these plans are tied to employers or employer choices about what types of health insurance to offer employees. Employees can use HRAs or FSAs only if they are offered by an employer. If an employer does not offer an HSA-compatible health plan option, an employee needs to either buy her own insurance or forego making HSA contributions.
Regardless of employer decisions, why shouldn’t everyone be able to contribute to an HSA, the most tax-advantaged account in the tax code? If the policy objective is maximizing savings for healthcare expenses, the savings vehicle should not, in any way, be tied to characteristics of an insurance policy or decisions of an employer.
Restrictions on Who’s Bills Can Be Paid
For employer-financed plans, it makes sense to focus funds on caring for the employee and the immediate family. They are the immediate concern of the employer offering the plan. From a policy perspective, this is perhaps a serious shortcoming of these plans.
If we look at HSAs, though, the funds are not the employer’s funds. Even funds contributed by the employers become the employee’s once contributed. The employee can only use HSA funds to pay for his own medical expenses or those of his dependents. From a public policy perspective, why should the HSA owner be limited to paying only for those people?
Meet John, Mary and Peter
John is a healthy HSA owner who has contributed for years to an HSA and had some modest success with its investments. His HSA balance is $150,000.
John has a younger sister, Mary. She is a widow raising John’s nephew, Peter. Mary’s husband did not have much life insurance when he died shortly after Peter was born. Mary works a couple of part time jobs without benefits with schedules that allow her to spend a lot of time with Peter. She makes ends meet and provides a decent life for her son.
Unfortunately, Mary has little in the way of reserves for unexpected expenses. John helps out from time to time when things get really tight. Because Mary has individual coverage through the government Marketplace, her deductibles are relatively high. The policy has an out-of-pocket maximum of $8,300 per person (or, $16,600 for the family).
Peter’s Accident
One day, Peter is hit by a car while riding his bike. Fortunately, Peter’s injuries aren’t permanent, and with time they will all heal. Mary now has bills for $8,300, plus any of Peter’s medical bills that were not covered by insurance. Let’s say her total medical bills for Peter’s injuries comes to an even $10,000. Mary does not have $10,000 to pay those bills.
John loves his sister and his nephew, Peter. He wants to help pay for Peter’s bills. If John wants to pay for Peter’s medical bills from his own HSA, he must pay income tax on what he withdraws and a 20% penalty because Peter is not his dependent for tax purposes. Assuming Peter is in the 22% tax bracket, he would have to withdraw $17,241 from his account to pay the $10,000 medical bill, $3,793 in additional income tax, and $3,448 in tax penalties for not using his HSA funds for a qualified medical expense. The only reason the medical expenses were not qualified was his relationship to Peter.
This is insanity! John should be able to make that payment from his HSA without the $7,241 in penalties for helping his nephew! Restrictions should be on what the funds are used for, not who benefits.
HSA Contribution Limits
In our article on retirement plans, we pointed out the necessity of front-loading retirement savings as much as possible. Funds invested earlier have more time to grow, and annual limits on contributions seem to be counterproductive.
The same applies for HSAs. HSAs are great tools for helping to save for future healthcare expenses. Some (not all) families could pay out-of-pocket for relatively minor expenses, like an occasional prescription or office visit copay. The HSA, then would be a vehicle to save for large, unpredictable expenses. Such savings ideally would be front-loaded, just like retirement savings would be, meaning annual contribution limits don’t make sense. From a policy perspective, we should be encouraging accumulation to cover these expenses.
Also like retirement plans, we do not want HSAs to be infinite tax shelters for the very wealthy. As we suggested for retirement plans, we believe that limits based on account balance would be more appropriate. When an HSA balance is over $250,000, perhaps, further contributions cannot be made. If we loosen restrictions on whose medical bills can be paid from an HSA, perhaps a much larger cap is appropriate.
Personal Healthcare Savings Conclusions
We come to the same conclusion for the variety of personal healthcare savings plans that we did for the variety of retirement savings plans. In short, we would advocate for consolidation of various plans.
Premium-only ICHRAs provide a highly flexible way for employers to provide funding for employee health insurance. These have some merit as an option for insurance funding other than group medical plans.
For personal savings for what insurance doesn’t cover, modifications to HSAs with revisions to contribution limits, who may have one, and who may benefit from someone’s HSA seem to provide a path forward, with the elimination of HRAs (except the premium-only ICHRA), FSAs, and other personal healthcare savings accounts.