In our last article in this series on becoming your own financial advisor we spoke about the investment opportunities of life insurance and bonds.
In this, our final article, we’ll talk about insurance products called annuities and HSAs, also referred to as health savings accounts.
Investment Opportunities – Annuities
Annuities are insurance products that provide a source of monthly, quarterly, annual or lump-sum income throughout your retirement.
Annuities have both pros and cons.
- Tax-deferred growth of earnings
- No annual contribution limit
- Steady income stream during retirement.
- Very high expenses
- Annuity surrender charges
- Early withdrawal penalties
- Payments may be taxed as ordinary income
- No additional death benefit.
As you might have guessed, you can invest in annuities by purchasing them through life insurance companies, brokerage firms and other financial institutions.
Annuities, however, come with high fees. Because of this you should consider an annuity only after you’ve maxed out your other tax-advantaged retirement options. These may include any 401(k)s or IRAs that we discussed in our previous article.
In contrast to life insurance which pays a benefit when you die, annuities normally make payments for as long as you live.
The idea behind an annuity investment is to generate an income stream during retirement. An annuity is a contract between you and an insurance company that agrees to make periodic payments for a set period of time, or until a certain event occurs, such as your death.
Any money invested in an annuity grows tax-deferred. When you make withdrawals from the annuity, any amount you contributed is not taxed, but earnings will be taxed at your regular income tax rate.
Beneficiaries vs Annuitants
The owner of the annuity purchases the contract and is allowed to make changes to the policy. In an annuity, the annuitant is the insured person, and the beneficiary is the one designated by the owner to receive whatever is left in the annuity after the annuitant dies.
Many times, the owner and the annuitant are the same person, and the beneficiary is a spouse, child or other dependent. It is possible for the owner and the annuitant to be different people.
Who the annuitant is becomes significant when the contract is annuitized. When a contract becomes annuitized, the annuitant collects a fixed monthly payment from the insurance company, typically for life.
The annuitant’s age and life expectancy– not the owner’s age and life expectancy- determine the amount of monthly income.
Given the same policy, a 50-year-old annuitant would receive a smaller monthly payment than a 70-year-old annuitant because the insurance company would expect to make more payments to the younger person.
Types of Available Annuities
As with many financial products, annuities come in different types. They can be deferred or immediate. With a deferred annuity, your money is invested for a certain amount of time until you are ready to start taking withdrawals – this usually occurs during retirement.
With an immediate annuity, you start receiving payments shortly after you make the initial investment. You have the option of converting a deferred annuity into an immediate annuity if you want to start receiving payments sooner.
Annuities can also be either fixed or variable within the broader categories of deferred or immediate. With fixed annuities, the insurance company pays a fixed rate of interest while the account is growing. The annuity of this type is similar in function to a CD (but not FDIC-insured).
Fixed annuities can be life annuities or term certain annuities. Life annuities pay a fixed amount each period until the annuitant dies. In contrast, term certain annuities pay a fixed amount per period for a set amount of time –known as the “term”– and after that, the annuity is spent, even if the annuitant is still living.
With variable annuities, you choose from a selection of investments in mutual fund-like portfolios called subaccounts. The performance of those investments determine how much income you receive from the annuity.
Investments can be very conservative. For instance, a money-market subaccount, to very aggressive as in the case of an aggressive growth stock fund subaccount. Because they involve investments, variable annuities are considered securities. As such, variable annuities are regulated by the Securities and Exchange Commission (SEC).
I see the benefit of someone taking a piece of their retirement nest egg and purchasing a fixed rate annuity for a little piece of mind.
Investment Opportunities – The Health Savings Account
A health savings account (HSA) is a taxed-advantaged savings accounts that is used to pay for qualified healthcare expenses.
- Tax-deductible contributions
- Tax-free withdrawals
- Tax-free earnings;
- Funds roll over; portable.
- High deductible health care requirements
- Penalty if used for non-qualified medical expenses
- Monthly maintenance or per-transaction fees may apply.
You invest in a HSA through your insurer’s recommended bank or your company’s HR department. You can also invest in a HSA through your local bank or credit union and other financial institutions.
When getting an HSA, be sure to contribute enough to cover your deductible, plus a buffer for medical costs that are considered qualified. There are expenses which your insurer may not cover, like acupuncture or chiropractic care.
If you anticipate many out-of-pocket medical expenses in the future, try to max out your contribution each year.
Any funds in the account are yours forever. It doesn't matter if you switch jobs, change health insurers or move. Make sure to keep all your receipts – if your HSA is ever audited you will want to have them!
Health savings accounts are like personal savings accounts with the caveat that the money can only be used to pay for qualified healthcare expenses incurred by you, your spouse and your dependents.
What counts as a qualified expense is determined by the IRS – for more information read IRS Publication 502, Medical and Dental Expenses for details. Qualified medical expenses generally include your costs for the diagnosis, cure, mitigation, treatment and prevention of disease. They also include treatments for conditions that affect any part or function of the body.
Expenses for cosmetic reasons or for things that benefit your general health –for instance vacations (nice try!) -do not qualify.
Eligibility For Heath Care Savings Accounts (HSAs)
To be eligible for an HSA you must meet the following criteria
- You must be enrolled in a high-deductible health plan (HDHP). Your health insurance must have a deductible of at least of $1,300 for an individual plan or at least $2,600 for a family plan.
- You can't be covered by any other non-HDHP plan. The exception is limited coverage plans such as dental or vision.
- Can’t be enrolled in Medicare
- Can’t be claimed as a dependent on someone else’s tax return.
HSA Contribution Limits
The amount that your employer or you can contribute each year is determined by the IRS.
In the 2017 tax year, the maximum contribution amounts are $3,400 for individuals and $6,750 for family coverage.
If you are age 55 or older at the end of your tax year, you may add up to $1,000 more as a “catch-up” contribution. You must report contributions are reported on IRS Form 8889 and Form 1040.
High Deductible Health Plans (HDHP)
The thought of a high deductible in a health plan spooks most people. But let’s take a closer look before making judgements.
In a HDHP, your monthly premiums will be less – and in some cases, much less – than if you have a low-deductible plan. This limits your upfront healthcare costs.
For example, you might pay $250 a month for a plan with a $7,000 deductible, or $600 a month to bring that deductible under $1,000. That extra money per month can make a large difference in your finances.
In addition you may be able to find a high deductible plan that offers a 0% coinsurance, meaning that after your deductible is met, all your healthcare costs are completely paid for by the plan. This is as long as they are covered costs. Read the fine print on your health insurance policy to find out which costs are covered, and which aren’t.
The Affordable Care Act
You might find the above details pretty reassuring when considering a HDHP. Remember that under the Affordable Care Act (ACA), a long list of preventive services must be covered at 100%. This means you don’t pay a thing for these services -as long as the service is provided by an in-network provider. This occurs whether you’ve met your deductible or not.
Preventive services include things like colorectal cancer screening for adults, mammograms and HPV screening for women, depression screening for adolescents, and immunizations at any age. Look up the complete list on www.HealthCare.gov.
The Affordable Health Care Act will likely remain in force through 2017. However, it's not clear what will happen to various provisions of the ACA going forward. Bearing the above in mind, a HDHP might not be that scary, at least for now – especially if you are in general good health and don’t anticipate a lot of healthcare expenses.
An added bonus to an HDHP is that you can use funds from an HSA to pay for healthcare expenses. This effectively provides a discount – which is equal to your tax rate on any expenses- since contributions to your HSA are tax-deductible.
A few additional HDHP considerations
Many providers are willing to work with patients who have HDHPs to make healthcare costs more affordable. They might for instance, offer a discount for paying right away – which could be substantial – and you could still use funds from your HSA to pay.
Depending on your income, you may qualify for financial assistance that would help you pay for your share of the costs.
Don’t be afraid of asking your provider if they offer a discount if you pay right away, and if they offer any type of financial assistance.
Becoming Your Own Financial Advisor Summary
Throughout this series we talked about how you can become your own financial advisor. You can do it if you're willing to invest time and effort. We covered annuities and HSAs and a number of other planning strategies.
Along the way we considered the various options for investing your money and their pros and cons.
While not for everyone, becoming your own financial advisor affords you more control and flexibility with your investments.