Conscientious Financial Planning and Retirement Income Management | 201-741-9528
from Lonier Financial Advisory LLC, Osprey, FL

’Tis the Season for Open Enrollment

’Tis the Season for Open Enrollment

In my last post, I listed some year-end housekeeping and tax items. It’s open enrollment season, so this post will cover items related to employer sponsored plans.

Health insurance options and the ACA
Top of mind this season, health insurance—many companies are replacing non-compliant health insurance plans. This may be your first time in a high-deductible health plan (HDHP). The ACA doesn’t require a plan to be a HDHP, but its coverages were written to follow HDHP and HSA (Health Savings Plan) guidelines. HDHP premiums are lower in exchange for higher out-of-pocket (OOP) costs for deductibles, co-pays, and co-insurance. A lot of folks are fooled by this since the OOP does not include the cost of premiums. Look at the total cost when choosing plans—OOP plus premiums—that’s your max cost in any year, which typically you will reach only if you have a major claim. Even though you may not like paying higher co-pays with an HDHP, unless you have major claims every year or so, you may pay less all-in with a HDHP plan with higher co-insurance because it has lower annual premiums than with a higher premium plan with a lower deductible. So if you’re reasonably healthy, retain some risk, self-insure with a HDHP, and save some money. Spend your insurance dollars where it matters—protecting against huge losses. Medical bills are the number one case of personal bankruptcy in the U.S.

ACA and HSAs
Some companies are switching to lower premium HDHPs, saving employer premium dollars while keeping the employee premium about the same, which feels like a win since it’s not the typical annual increase. But with the HDHP, the employee pays more co-insurance up to a higher deductible, so to soften the blow, some companies are instituting and contributing to employee HSAs (even with the contribution, the employer saves overall dollars on the plan). Good for the employer and the HSA (if not the higher deductible at the same premium as last year) is good for us—hallelujah!

One bright spot of the ACA is that the HDHPs it supports are bringing HSAs out of the shadows. HSAs are a bona fide federal tax-trifecta—tax-deductible contributions, tax-deferred growth, and tax-free distributions to pay for health expenses. In short, a tax-deductible tax-free healthcare IRA.

You can only contribute if you are in a HDHP, so if you have the option, go for it. And contribute to the max allowed on top of your employer’s contribution ($3,250/yr for individual coverage, $6,450 for family coverage, +$1,000 for 55+, combined employer + employee). You can’t contribute once you’re part of Medicare (age 65), so build up the account while you can. If you enroll by December 1, you’ll be eligible for the full 2013 contribution, though you must maintain HDHP coverage through the end of the next year, or pay taxes and a 10% penalty on the contribution.

Many underestimate healthcare costs in retirement, thinking Medicare pays for everything—not true. A HSA lets you pay for those uncovered expenses, including Medicare Part B and LTC insurance premiums and LTC expenses, with tax-free dollars. And if your healthcare expenses are relatively low, you can spend it just like a traditional IRA on anything, paying taxes on the distribution—and the account is not subject to RMDs like a traditional IRA.

HSAs are long-term accounts, held by a custodian, which you can invest in various funds just like an IRA. They are portable, so you keep them if you change employers. You don’t have to spend them down every year, like a FSA (Flexible Spending Account). Distributions are tax-free for qualified healthcare expenses at any age, though non-healthcare withdrawals before age 65 can incur a penalty, just as from a traditional IRA before age 59-1/2,

Finally, once you are in a HDHP and set up a HSA, you can make a one-time tax-free rollover contribution from your IRA to the HSA up to the annual max—in effect, a Roth conversion, but without the tax! Again, you need to maintain HDHP coverage for a year after the contribution or pay taxes and 10% penalty on the rollover. One more tax-advantage for starting a HSA this year.

What about the FSA?
With the wider adoption of HDHPs and HSAs, the FSA will start to fade away. HSA rules prohibit having the old general purpose FSA and a HSA at the same time. If you have a HSA, any FSA must be limited to dental, vision, preventive care, or for out-of-pocket non-covered expenses once the HDHP deductible is met. So if you have a HDHP and a HSA, there’s little point to having a FSA as well—fund the HSA, it has many more advantages than a FSA. Most companies moving to HDHPs and HSAs will drop FSAs.

Meanwhile, the IRS sweetened the FSA somewhat this year by permitting carryovers up to $500 into the next year and beyond, without affecting the annual $2,500 maximum election. These carryovers do not expire, unlike the grace period provision, until you leave the plan. This expands the old use-it-or-lose-it rule, and makes planning the amount to withhold for the following year less critical, since if you under-spend, you can roll it forward.

FSAs remain locked-in to the sponsoring employer. If you leave the company, you can’t take it with you except during the COBRA period after termination, if you opt for COBRA coverage after employment. Otherwise, bye-bye FSA.

Also, the carryover is an either/or with the grace period provision, which allows using up the prior year’s leftover balance by March 15 of the new year.

To make this happen, the sponsoring employer must amend the plan to add the carryover option while removing the grace period if the plan has one. If the employer can get this done by year-end, the carryover will be in effect for 2013 into 2014.

Small-Business Retirement Plans—Crucial for the Self-Employed
If you run a flourishing mom and pop business, don’t feel left out of the retirement plan party. Options for mom and pops allow deferring over $100,000 a year, pre-tax! If you have the cashflow, this means Uncle Sam contributes upwards of $40,000 to your savings—instead of you sending him the $40,000 as additional taxes. Meanwhile, you’re building a secure retirement for the day you pass your business on to junior.

The “solo” 401(k) is a conventional 401(k) plan with just a husband and wife as members, simplifying administration. Each of you can contribute $17,500 ($23,000 50+) like any employee, and your company can add up to 25% of compensation up to combined total of $51,000. If your tax situation permits, this can be done as taxable contributions to a tax-free Roth 401(k).

A SEP IRA permits the same upper limit, but the company makes the entire contribution, far exceeding the $5,500 ($6,500 50+) limit of an individual IRA account. One caution for both plans is that when other employees come on board, they get the same company contribution as mom and pop, so you either have to like them very much, or change your tax deferral approach!

If you have even more cashflow, consider a defined benefit plan, more work to setup and administer, but with more and higher options for downstream pension benefits. Yes, mom and pop can set up a pension plan, just like the big boys use to, back when they could afford it.

Check here and here for more information.

So Much to Save For, So Little Time
We all have a limited amount of funds we can put aside for the future, so save to your best advantage. Start with saving enough to cover the employer match in your 401(k). Then fund an HSA to the max (make sure the HSA has reasonable fees and account investment choices; if it doesn’t, look for another HSA custodian).

After that it depends. Is your 401(k) a low-cost plan with broad market index choices or an expensive plan with poor investment choices? If it’s a good plan, max it out.

Otherwise, start by funding an individual traditional IRA up to the deductible max or a Roth IRA up to the after-tax max that your AGI permits. Invest in a global market portfolio that is suitable to your balance sheet. Then fund your 401(k) to the max, unless it’s truly a horrible plan (there are fewer around since the fee disclosure rules have tightened). If it has high fees and poor choices, you may be better off saving more sensibly in a taxable account.

If you’re a mom and pop business with great cashflow, max out a solo 401(k). Set it up with a low-cost provider committed to broad-index investing like Vanguard.

However you slice it up, make sure you save a little more (1%!) this year than last.

Happy open enrollment season!

–Michael Lonier

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