Abstract: Out-of-pocket costs have doubled over the last two decades leaving many people to forego necessary health care or reduce savings for retirement. The recently enacted Trump tax bill does not assist the people most affected by higher out-of-pocket costs. Alternative more effective policy changes designed to assist people with out-of-pocket costs include – (1) elimination of use-or-lose rule for Flexible Spending Accounts, (2) a tax credit to replace or augment tax deductibility to Flexible Spending Accounts and Health Savings Accounts, and (3) exempting prescription drugs from deductibles on high-deductible health plans.
Introduction:
The amount a typical person pays out of pocket for health care has doubled in the last two decades, even though the portion of people with health insurance coverage has risen. A primary reason for the increase in the share of health expenses incurred by fully insured individuals involves changes in health insurance plan rules including higher deductibles, copays, and coinsurance. The growing popularity of high-deductible health plans coupled with health savings accounts is probably the most important change leading to higher out-of-pocket healthcare expenses.
The growth in out-of-pocket health costs exacerbates several financial and health problems.
Many insured people with high deductibles and coinsurance incur large levels of medical expenses and take on medical debt.
Many fully insured people now forego treatments and procedures including treatments for chronic conditions.
Many low-income and middle-income households cannot afford to save more for either retirement or health care and can only save more for health care by reducing the amount they save for retirement.
The tax code allows for two tax-preferred financial vehicles -- flexible saving accounts and health saving accounts -- to assist individuals saving for health expenses. Potential modifications to these accounts are discussed below.
Flexible Spending Accounts:
Flexible Spending Accounts are set up by employers for their employee use often through a cafeteria plan. People who do not work at a firm offering a flexible savings account cannot open an account on tbeir own. However, the flexible savings account is not tied to any particular health insurance plan.
Funds for the flexible savings account are pre-tax funds and are not subject to federal or state income tax. The funds are not reported on the federal income tax form.
Funds which remain in the account after the end of the year are returned to the employer. Moreover, funds left in a Flexible Spending Account by a departing employee are returned to the firm. Go here. I don’t understand the logic behind taking away funds in a Flexible Savings Account from a newly unemployed person who loses access to employer-based insurance when these funds could have been used to purchase COBRA insurance.
Employees who use funds in a flexible savings accounts for non-medical related expenses are required to reimburse the account for the expense and may be subject to penalties.
The current legislative efforts to expand use of flexible savings account in the big, beautiful bill, championed by the Trump Administration and Republicans in Congress involve an increase in the annual contribution limit from $5,000 to $7,500 and a rule change allowing for contributions by people with spouses who have a health savings account.
A substantial portion of workers who are offered a flexible savings account at work choose not to participate. (I was unable to find a precise authoritative estimate of the participation and non-participation rates.)
EBRI found the average flexible savings account balance was around $1,300 and around half of all account numbers forfeited unused funds in the account.
The participation rate cannot be improved by a higher contribution limit. Furthermore, an increase in the maximum contribution amount will not induce additional contributions by workers who are currently contributing far less than the maximum level of contribution.
The provisions in the big, beautiful bill tend to assist people who are current able to save some funds for health expenses and do very little to stimulate additional savings for health care by people who are limited by low disposable income, low savings, fear of forfeiting contributions due to the use-or-lose stipulation, and general complexities associated with the accounts.
These proposed modifications do not eliminate the tradeoff between saving for retirement and savings for health care.
Alternative more efficient modifications to rules governing flexible spending accounts would target households who are not currently savings for out-of-pocket health expenses. These rule changes include:
· The replacement of tax deductibility with a tax credit to better assist low-income and middle-income taxpayers.
· Allow the unused funds to remain in the account or be transferred to a non-deductible IRA or 401(k) plan.
· Allow departing employees with a balance in a flexible spending account to use the funds in current year, spend the funds on COBRA and/or roll over any unused funds to a non-deductible IRA or 401(k) plan.
· Expand the eligibility for flexible savings accounts to all people with health insurance. Currently, only employers offer flexible savings accounts and the benefit is not offered to people with state-exchange health insurance.
Interestingly, the big, beautiful bill includes a provision allowing for the rollover of funds from a flexible spending account to a health savings account. However, the rollover is typically only allowed for people who did not have a high deductible health plan in the last four years. Also, the transfer from the flexible spending account has to be done quickly before the unused funds in the account revert to the firm. This provision will not benefit many people.
Health Savings Accounts:
Health Savings Accounts are tax preferred savings accounts linked to high-deductible health insurance plans.
Only individuals currently insured by a high-deductible account can contribute to a Health Savings Account.
The entire contribution to the Health Savings Account is deducted from income. Taxpayers do not have to itemize to claim this deduction.
Funds in a Health Savings Account used for qualified medical expenses are never taxed.
Funds used for a non-medical purpose prior to age 65 are subject to a 20 percent penalty and federal income tax.
Funds used for a non-medical purpose after age 65 are not subject to a penalty but are subject to tax.
The big, beautiful bill impacts Health Savings Accounts by expanding eligibility, by increasing contribution limits and by exempting additional expenses from federal income tax and penalty.
The big, beautiful bill expands Health Savings Account eligibility to some people who are currently not eligible including people with a Medicare A plan, people with spouses covered by a Flexible Savings Account, users of on-site clinics, and people covered by bronze and catastrophic state exchange insurance.
In general, the existence of a high-deductible health plan remains a condition for making contributions to Health Savings Account. One possible exception is coverage under a bronze state exchange plan.
The big, beautiful bill doubles the contribution limit for health savings accounts; however, the additional allowable contribution is phased out for higher income individuals. This provision will do very little to assists the one-in-five account owners who do not fund their account and the significant number of account owners who do not fully own their account.
The big, beautiful bill also contains some provisions facilitating catch-up contributions to Health Savings Accounts. Additional catch-up contributions to Health Savings Account do not benefit people who are having the hardest time saving for health care or retirement.
The big, beautiful bill also expands allowable deductible expenses for expenses on sports and fitness programs.
Most experts, including those at the Tax Policy Center, have concluded that the changes to the rules governing Health Savings Account in the big, beautiful bill primarily favor high-income people and that the bill does very little for people most in need of assistance.
The most effective way to give more of the advantages of Health Savings Accounts to low-income and middle-income individuals is to replace the existing tax deduction with a credit. The tax credit should reduce the number of people with high-deductible health plans who do not fund their Health Savings Account.
Tax deductions have a larger impact on contributions by higher income people with higher marginal tax rates. Note provisions in the big, beautiful bill which exempt tip and overtime income from taxes lower taxable income and reduce the need for some taxpayers to make contributions to health savings accounts or retirement accounts to avoid taxes. Hopefully, part of the savings from the tax cut will be earmarked to saving for retirement or health care.
Many high-deductible health plans subject all expenditures on prescription drugs, even drugs used for chronic health conditions to a deductible. This feature of high-deductible health plans can lead many people to forego treatment of chronic conditions, an action that could lead to large and expensive health problems in the future. Alternatively, this feature of high-deductible health plans would lead rapid depletion of savings in a health savings account.
The most effective way to mitigate adverse impacts of high deductible health plans on patients with chronic health conditions requiring extensive use of prescription drugs is a regulation requiring partial reimbursement on all prescription drugs prior to the insured reaching his or her deductible.
Conclusions: Out-of-pocket health expenses have doubled over the last two decades. Changes in the big, beautiful bill to Flexible Spending Accounts and Health Savings Accounts only mitigate this problem for wealthy people who are not struggling with saving. The most effective way to assist people who are struggling with health care and retirement saving is ending the use-or-lose stipulation attached to Flexible Spending Accounts, replacing tax deductions with a tax credit and modifying some provisions of high-deductible health insurance plans.