10 MIN READ
Open enrollment affects several areas of your overall financial plan, including health care costs and benefits, life and disability insurance, retirement planning, tax planning, and more. So why only devote a few minutes right before the deadline to it? It’s worth doing some homework, using the suggestions we provide below as a start.
It’s that time of the year again. Open enrollment for the coverage year 2022 goes from November 1 to December 15. We get various notifications from our HR departments, brochures that explain all the benefits, and maybe some live sessions from HR with invited guests from some of the providers. Then what? How do we make decisions about our benefits?
Dazzled and Confused
A survey by Aflac shows 74% of employees don’t understand a number of key terms, including things like deductibles, copayments, and co-insurance, etc. And even if they do understand the policies, when employees receive their bills, the vast majority are surprised by the out-of-pocket costs.
Asking our colleagues or HR departments for help is a start, but unless they are experts and understand our unique situation, their advice may not be very helpful. The reality is that many of us make suboptimal decisions. Experiments conducted at Columbia and other universities find that the likelihood that participants will choose the cost-effective health plan for their situation out of two available is similar to correctly guessing a coin flip, about 50%. Worse yet, a whopping 92% of people simply choose the same benefits year after year. If it ain’t broke don’t fix it, right?
Here is our new challenge this year. While sitting down and spending time reviewing health care and 401(k) options does not exactly sound like fun, it’s not all that bad once you consider the value of the benefits that your employer offer. Making the right insurance decisions can help you avoid big mistakes and save you money over time. Getting an early start on or making a timely correction to your retirement plan can make a big difference to your retirement nest egg. And these are just two of the benefits. So do something different this year, let’s do a bit of homework and make better choices for key benefits including health, retirement, life and disability, and tax-advantaged savings. While this post is not going to make decisions for you, but it will help yo make more informed decisions that may have a relatively big impact on your financial plan.
Some employers let you choose between a traditional, low deductible plan (a PPO) and a high deductible one (HDHP), while some only offer a HDHP these days. Either way, you need to understand the costs and benefits of your options to minimize costs and avoid surprises. The first step is to spend some time reviewing how you used health services this year and what you may expect next year. How often do you and your family see a doctor? How often do you use prescription drugs in a year? A good way to do it is to download the transactions of the card or the account you used to make the payments, and you will be able to see healthcare-related expenses.
Then consider what may differ next year. Do you expect higher or lower usage? You may have a planned surgery or are thinking about having children. These questions may affect your costs. For example, if you are considering having children and are on a high deductible plan, make sure you check the coverage for pregnancies, to avoid surprises.
Understand the Differences
For each plan, consider the monthly premiums and other features that affect your costs. You are responsible for a monthly premium that varies across plans. When you use your health insurance, you are responsible for at least part of the costs. The annual deductible is what you are responsible for each year before the insurance starts covering any of the costs. After that is met, how much the insurance company will cover depends on the coinsurance amount of the plan. If your plan has an 80% co-insurance (quite common), it means that the insurance will cover 80% of the cost, and you the remaining 20%, after the deductible for the year is met. Typically, you may not be responsible for the 20% co-insurance after you have paid a given amount for the year, called the stop-loss limit. Once this limit is met, the insurance company pays 100% of the costs (always after the yearly deductible is met). Typically, plans also have a maximum out-of-pocket amount. This is the total out-of-pocket limit you can be responsible for each year. For high deductible plans that offer an HSA account (see below), the annual out-of-pocket maximum for 2022 has to be at or below $7,050 for an individual and $14,100 for a family.
Estimate the Costs
Whether you have a choice of plans or not, knowing your costs can help you budget for them over time. Especially if your only option is an HDHP, because you could be facing relatively high costs. Here is a comparison between two hypothetical employer plans for an individual.
|HDHP||$100×12 = $1,200||$5,000||80%||$7,000|
|PPO||$250×12 = $3,000||$2,000||80%||$4,000|
Under the high deductible, the maximum you will pay over the year is $1,200 + $7,000 = $8,200. Under the PPO plan, the maximum you will pay is $3,000 + $4,000 = $7,000. This does not mean the HDHP is bad for you. It could still be your best choice but be prepared that you could end up paying $8,100 in a year.
If you have reviewed your usage you can get an estimate of what you may expect to pay. For example, say you expect medical bills of $4,000 next year. Under the high deductible plan in our example, you’d pay $4,000 + $1,200 (premiums) = $5,400. Under the PPO plan, you’d pay $2,000 (deductible), a 20% coinsurance on the remaining $2,000, so $400, plus $3,000 in premiums, for a total of $5,400. Exactly the same under each plan.
Which is Best?
For the plans in our table, if you expect bills higher than $4,000, the cost-effective choice is the PPO. If you expect bills less than $4,000, the cost-effective choice is the HDHP. That’s a very basic example, but here is the lesson. If you are healthy and don’t expect to see a doctor often, you can opt for an HDHP. But make sure you are prepared and able to afford the maximum out-of-pocket expense for the year, in addition to the premiums, in case you have higher-than-expected medical costs.
If you or others in the family see the doctor more often, the traditional plan may be better for you. If you are pregnant or planning to have children, check and compare the maternity coverage of each plan you are considering. The high deductible plan may have special coverage for maternity, otherwise, you may be better off with a traditional plan. If you have young children, play sports, plan a surgery, spend a lot on prescriptions, always consider potential costs before making a decision, but the traditional plan may be better for you. If you expect similar costs between the two plans, like in our example, the HDHP may be the way to go if it gives you access to a health savings account or HSA.
Health Savings Accounts (HSA)
If you have an HDHP plan, it may also have access to an HSA. The HSA allows you to make tax-free contributions to pay for medical expenses, this year or at any time in the future! And there is more. The money you contribute is not subject to either payroll or federal income taxes. If you save the money in an HSA for future use, your money grows tax-free, and HSA plans typically offer investment options. If you later use the savings to pay for medical expenses, you are never taxed on either your contributions or the earnings. This favorable tax treatment means that it makes sense to use funds from your checking or savings account to cover current medical expenses, instead of dipping into your HSA money. For some people, it makes sense to use HSA accounts for retirement planning, as we discussed here.
Something else you may not know about HSA is that you can establish one even if your employer does not offer it, provided your HDHP qualifies. Also, if you start your job late in the year and are eligible for HSA on Dec 1 (or earlier) you are eligible for the entire year, so you can make the yearly contribution to it. If you are looking for ways to reduce your taxable income, fully funding your HSA can be a good way to do it.
Health and Dependent Care FSAS
Some employer plans offer you the ability to contribute to Flexible Spending Arrangements or (FSA). There are two types: the health FSA, for reimbursement of medical expenses, and the dependent care FSA, for reimbursement of dependent care services such as daycare, preschool, and summer camps. Your company may offer one or the other, or both. For 2022, the contribution limits are $2,750 for the health FSA and $5,000 for the dependent care FSA (married filing jointly).
Contributions are not subject to Social Security and payroll taxes or federal income tax. If used for eligible expenses, they can provide good tax savings. For example, assume your income falls into the 22% tax bracket. Your total savings from using the FSA can be close to 30% (22% income tax + 1.45% medicare + 6.2% Social Security), and even greater than that if you pay state income taxes. For both FSA types, however, it’s important to estimate the amount to contribute based on what you actually expect to use during the year. If the plan allows you to carry over unused amounts to future years, the IRS set a maximum carryover amount of $550 for 2022.
If you use a dependent care FSA, the amount of the benefit will typically cause a reduction in the child and dependent care credit (not to be confused with the Child Tax Credit, which is not affected). Using an FSA can provide more tax savings than using the child and dependent care credit depending on your marginal tax rate.
If your company offers a retirement plan, like the 401(k) or similar plan, open enrollment is a good time to review and make changes to your current elections. The key questions to decide on are how much to contribute and how to allocate your investments across the different options. And no, choosing funds based on their names is not a good idea. If your company does not have a plan, this is a good time to think about saving for your retirement. We have discussed how to make choices among different retirement savings options in a previous post, including, but not limited to, your company’s 401(k). Take a look here to start.
- Don’t leave money on the table. Max your employer match.
- Set a retirement goal and consider whether sources outside your 401(k) make sense. For example, if you are in a low-income tax bracket, consider contributing to a Roth IRA.
- Consider your HSA as a source of retirement savings.
- Most importantly, read this post for more tips to tune-up your retirement plan!
When is the last time you thought about how much life insurance you need? Many employers offer group life insurance. Some coverage is paid by your employer, and you can consider electing additional coverage, for a premium. The first step is figuring out how much insurance you need. There is no simple answer, but one way to think about it is this. If I were to die tomorrow, how much would my family need to maintain the same standard of living? If the answer is zero because no one depends on your income, then you may not need to worry about supplemental life insurance. If you think you need more than your company offers, then you need to get additional coverage. A simple rule of thumb is that you need at least 5-6 times your gross income. If that coverage comes to above a million dollars, then you may want to consider using a financial planner to review your overall finances, including benefit choices.
I recommend you get quotes on term insurance from other providers besides the one offered by your plan. First, you may get a better rate elsewhere. But most importantly, if you leave your company you may lose the plan coverage, while the coverage you take outside of your employer stays with you, and so does the level of the premium. In contrast, if lose the employer coverage and you have to get new coverage, you will be older than when you first got coverage, and will likely have to pay a higher premium. Consider having your own term insurance for the amount you need. You can select level payments of different durations all the way to 30 years. Check out some average rates to start.
Open enrollment is also a good time to consider disability insurance. For most of us, the ability to work and earn an income is our largest asset, and we should protect it with disability insurance.
Your employer may offer some disability coverage. Ask yourself if the amount provided is enough for your needs in case you cannot work due to illness or injury, and keep in mind that the coverage provided through the employer plan is most likely considered taxable income when paid out. Check the so-called elimination period, which is the period you will need to cover on your own before the insurance starts to pay. Keep this in mind and consider it when planning for your emergency fund. Just like group life, disability insurance provided through your employer is lost if you leave your job.
Most disabilities are caused by illnesses rather than accidents. A typical worker age 35 in an office job and who leads a healthy lifestyle has about one in four chances of becoming disabled for three months or longer during their working career. If your family relies on your income, consider going outside your plan to obtain some level of disability insurance. Insurance companies only underwrite policies if you are employed, and typically for up to 60% of your income. Read our post on disability insurance to learn more.
Your employer benefits can be many and cover several aspects of your financial life. Unfortunately, employers may not always do a great job at highlighting the value of the benefits offered. But it’s worth doing some homework, using the suggestions we provided or talking with a trusted advisor.
About the Author
Massi De Santis is an Austin, TX fee-only financial planner. DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow and protect their resources throughout their lives. As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.
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