Pay Now - Pay Later, Why Our Staff Need Our Help

Can behavioral finance solve the problems with retirement planning?

Yes, do “it” for them!
Our staff face very different challenges today in planning for lifetime financial security from what previous generations did.

The Pension Protection Act of 2006 was the biggest pension reform legislation enacted in more that 30 years. What made it so different was its recognition of behavioral finance. I’m talking about the accumulation phase of retirement savings and the realization of how difficult it is to build a nest egg.

The problem, specifically, is that 1/3 of those eligible to participate in a 401(k) or other employer sponsored savings plan, do not enroll. The Pension Protection Act was designed to change that.

But first, why is it so difficult to have a savings plan?

Why is it Americans have no savings? It is because of the consumer-based culture (better to buy than to save) and here is the evidence.

1) Savings provides no short-term benefit unlike a mortgage, which results in being able to buy a home.
2) In contrast to an unavoidable chore, i.e. taxes, there are no deadlines.
3) Unlike penalties that can come from, for example, failing to have car insurance; failing to structure financial planning entails no penalties.
4) Education is not enough. Research has shown that there is a substantial disconnect between what financial seminar participants intend to do and actually do end up doing. In fact, there is very little difference in activity between those who do take educational seminars and those who do not (7% vs. 14% - 2001 study: working paper University of Chicago)

What are some of the reasons given for not saving?
- To little money available for savings after paying for basic living expenses
- Money needed to pay off debt
- Unexpected drop in income
- Changing one’s mind
- Lack of self-control
- Loss aversion – risk

And when they do make a decision to save, they follow the path of least resistance when choosing plan options – often least risky and not necessarily in the person’s long-term best interest. Once they choose an option, they are reluctant to revisit it, or to increase contributions as salaries rise, for example. To make matters worse, employees may become paralyzed by having too many options, which prolongs any decision and can reduce their ability to make a rational decision.

The bottom line is this, how employees respond depends upon how retirement plans are presented. For example, automatically enrolling in an employer sponsored plan results in a higher rate of participation. Employers who actually increase employee contribution rate over time actually find employees go along and overcome the “psychological factors” to do nothing that comes from procrastination, lack of inertia, status quo bias, and a general unwillingness to make small sacrifices today for a greater gain down the road.

The reality is that very few people actually achieve all their goals. According to the 2007 Fidelity Research Institute, a typical US household was in track to replace only 58% of its income in retirement, not the suggested 85%. And among retirees 55 years of age and older who were surveyed, more that half (53%) retired earlier than planned. Further, employees who expected retirement income to account for 28% of income in retirement reported it only accounted for 6%.

So there you have it, too often decision-making biases and shortcoming get in the way of your employee’s ability to choose the “right” things. It is up to you as the “protector/employer” to do the right thing and get together with a financial planner and minimize the behavioral variables by, for example, automatic enrollment, escalating contributions rates and age appropriate investment plans.

Our staff need us to do this for them, it is complicated stuff and we all have a tendency to put it off because it is not fun, don’t we.

Employees know that aside from what they create for themselves, there are few, if any, financial safety nets available to them in old age. The retirement plan is only a hope, and Social Security is uncertain. Longevity and health care costs are increasing. Family support is not as available as in prior generations, and arguably, there are also unrealistic expectations about appropriate savings rates and expected investment returns.
The realty is that the employee’s central concern about how to maintain his or her standard of living into old age is not adequately addressed; the additional risks of longevity, inflation, and principal loss remain for the employee. In a Wealth Management 101 exam, the financial industry would—or should—get an F; as they have not proposed a solution that truly meets the employee’s needs.

How can you help?
With respect to age appropriate investing, there has been a shift as big, exciting, and challenging as when Markowitz’s work first forced investment professionals to recognize the importance of investment diversification or asset allocation. And that shift has been into hedging and insurance as additional means to an investment’s return.
Employees now have access to inflation-indexed annuities for their IRA accounts through a new distribution channel that offers meaningful competition: real-time, apples-to-apples quotes from several top insurance companies. This development may be as big in investing industry as the shift from loaded to no-load mutual funds or from the commissioned broker to the fee-only planner model.

So, your role is to provide retirement planning counsel to your employees for the intangible return of being recognized as a caring, supportive leader in your practice. It is already a win-win; why not make it a win-win-win. Do it now, pay now or pay later.

Health Savings Account Can Save Your Dentistry Practice “Real” Money

Rising health care costs including dentistry are taking a toll on Americans. According to a recent report by a consulting company, Mercer Human Resources Consulting, health care premiums paid by employers rose 6.1% in 2006. If you provide health care to your employees, these premiums are eating away at your profitability.

While managing health care costs is becoming a priority for our law makers, the debate for national health care continues. But there is a government program already in place that can help you and your employees reduce health care costs. This is the Health Savings Act (HSA) which was enacted by President Bush in 2003.

Employers Benefit from Reducing Costs
What if someone walked up to you and said your dentistry practice can save money with respect to health insurance while still maintaining the same level of care for your employees? This sounds almost too good to be true, but if you incorporate HSA into your health insurance coverage, you can make this happen.

The HSA program is meant primarily to benefit individuals, but employers can use it to reduce their insurance costs as well. Here is a brief summary of how the program works. Individuals can reduce their insurance premiums by enrolling in a qualified high-deductible plan and simultaneously opening an HSA through a financial institution. The HSA would be funded (up to the amount of the insurance deductible or the maximum ceiling amount) ahead of time, either by the employee or employer. Most medical expenses (including the insurance premium) can be paid from this account. The beauty of the HSA is that all money contributed to the account by the employee is considered pre-tax (like a 401(k) or IRA) and therefore reduce the employee’s taxes.

For employers, the HSA can be used to cut your health care costs dramatically. First off, you can lower employee premiums by enrolling in a health insurance plan with a higher deductible. Then help your employees sign up for a HSA and fund it at the start of the enrollment period. While your premium cost has dropped, the good news is that you are not taking anything away from your employees. Your employees get the same level of health care service. To the extent the employer contributes to the HSA, the employee does not realize the funded amount as income.

For 2006, the highest deductible for your employees under the HSA program is $2,700 for a single person or $5,450 for a married couple. In 2007, the highest deductible for a single person is $2,850 and for a married couple, $5,650.

As the employer, the cost for paying the employee health care plans and also funding their HSA accounts are fully expensed each tax year. On an after-tax basis, the total cost of the health insurance plan with the higher deductible plus your funding of the HSA for your employees will be less than what you are currently paying. By using HSA, your gross payroll will be smaller which has the additional effect of reducing your contribution for your worker’s social security payment. At the same time, your employees can continue to enjoy the same level of health care service.

Your Employees Benefit Too with HSA
In addition to dropping the cost of health care, your employees will get some additional benefits. For example, in situations where the health insurance will not pay for a particular procedure, this amount can be paid from the HSA which you have already funded. Additionally they can use the HSA to pay for dental care, eye care, and even non-traditional medicines.

Also, the HSA account would be owned by the employee with the added benefit that the unused amount can roll forward into the next year and taken with them if and when they change jobs. In the case where an employee has excellent health, the funds in the HSA can be invested in mutual funds or money markets – similar to an IRA.

Summary
In lieu of a grand plan to reform health care, the government has created a program - the Health Savings Act - that can help employers reduce the cost of their employees’ health insurance. By allowing an employer to sign up for a plan with a higher deductible, the insurance premium will drop. At the same time, employers will sign up and fund their employees’ HSA account. Both of these costs can be expensed. Thus, nobody loses anything and the health care costs for the employer decreases. It’s a win-win for all!

Posted by Henry Wong (hwong@pariveda.com)

Walking Through the Economics of HSAs – Big Savings

From our cursory overview of Health Savings Accounts signed into law by President Bush in late 2003 as part of the Medicare bill they seem to have outstanding potential to help families and individuals both lower current health care costs and sock away tax-free funds for future qualified medical expenses. Let’s dig a little deeper and quantify the economic benefits to participants by walking through a real-life comparison.

As noted in our first post on this topic, the Health Savings Account (HSA) program works in conjunction with high-deductible insurance plans. Instead of purchasing traditional, low-deductible insurance participants purchase qualified high-deductible insurance (at least $1,100 deductible for individuals, $2,200 for families in 2007) while setting up a tax-deferred Health Savings Account with a financial intermediary. The high-deductible insurance offers the Health Savings Plan participant savings in the form of lower annual premiums while the Health Savings Account affords a tax-advantaged means of saving for medical expenses.

HSAs can be funded up to the lesser of the insurance plan deductible or a government imposed maximum - $2,700 in 2006 and $2,850 in 2007 for individuals, $5,450 in 2006 and $5,650 in 2007 for families. As medical expenses are incurred, the participant may elect to pay for them using HSA funds. Any HSA contributions made by the participant, whether used during the year or left to accumulate, can be deducted from gross income come tax time.

High deductible insurance has historically been viewed with the stigma of lower quality coverage perhaps owing to the demographic it was originally intended to serve – those otherwise un-insurable. Yet with the advent of HSAs, the plans have been re-worked to appeal to a broader audience, with coverage typically similar to traditional health insurance offerings. Check out your insurance provider’s offerings and we think you’ll see what we mean.

Nonetheless, in order to conduct a relevant economic comparison between traditional and HSA insurance options, it’s crucial to ensure that each plan’s benefits are identical, or at least very similar. For our analysis we chose offerings from Blue Shield of California, specifically the “Shield Spectrum PPO Plan 1500” (traditional insurance) and the “Shield Spectrum PPO Savings Plan 2400” (HSA qualified). Our selection of Blue Shield of California as an insurance provider and the specific plans chosen are not recommendations, but instead meant to merely serve as an example of how we go about evaluating comparable offerings. There are certainly a vast number of health insurance providers available to you and product offerings that may, or may not, be more suitable.

In order to keep our analysis succinct we consider only coverage for a 40-year old individual in this post. It’s likely, though not confirmed, that evaluating family coverage as well as individuals of different ages will result in similar economic conclusions. If there’s interest, perhaps we’ll formally cover additional comparisons in the future. Let us know your thoughts.

Comparing Coverage
A quick overview of the comparability of the plans: The traditional insurance offers individual purchasers a $1,500 annual deductible and $40 fixed co-payments while the HSA-qualified offering has a $2,400 annual deductible with $35 fixed co-pays. Upon reaching the deductible, subscribers to the traditional plan make 30% co-payments with preferred providers (50% for non-preferred) until their out-of-pocket expenses reach $6,000 per year. Interestingly, individual subscribers to the HSA-qualified offering make identical 30% preferred provider co-payments only until reaching $3,200 of out-of-pocket expenses in a given year.

Readers can find a thorough comparison of the two plans here, but all-in-all we view the plan coverage is very similar.

Comparing Apples with Apples
In comparing the potential benefits of pairing a qualified high-deductible insurance policy with a Health Savings Account relative to traditional health insurance it’s necessary to look at each option on an after-tax and “apples to apples” basis.

In this analysis, there are two different tax effects that need to be considered. First, any HSA contributions provide the participant valuable tax benefits in the year they’re made, but leave funds tied up in an account that can only be accessed for health-related expenses. Alternatively, individuals subscribing to traditional insurance coverage receive no tax break for HSA deposits, yet the money they use to pay for their health expenses is not constrained – it could be used for healthcare, clothing, or even entertainment (perhaps a big-screen TV?).

Clearly the different constraints on the cash used to pay for medical expenses under the two strategies make this an “apples to oranges” comparison. Yet there is a way in which to make them directly comparable – simply assume any remaining funds in the HSA account at year-end are liquidated, paying all taxes and penalties needed to do so. Then, in each case, the individual would maintain comparable insurance throughout the year, and begin and end with un-encumbered cash.

From a practical perspective, the process of liquidating an HSA account at the end of the year is a “worse case” scenario that makes little sense, and we advise against doing so. Yet from a theoretical perspective it does serve the purpose of providing a better economic comparison between the two strategies and allows us to confidently state that “HSA accounts provides at least this much value relative to their traditional counter-parts”.

The second set of tax implications that need to be considered is the affect of itemized deductions on schedule A of the individual’s annual tax returns. If you recall, medical expenses (including insurance premiums, deductibles, co-payments, etc.) in excess of 7.5% of the tax filer’s Adjusted Gross Income are typically eligible for deduction. So, while out-of-pocket costs for the traditional insurance buyer may be higher, the possibility of an economic benefit afforded through itemized deductions is also higher.

However those choosing the HSA strategy are further disadvantaged relative to traditional insurance buyers when it comes to itemized deductions. According to the Internal Revenue Service you cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) that are equal to the tax-free distribution from your HSA. In fact, you cannot include any contribution to the HSA or any distribution from the HSA, including distributions taken for non-medical expenses, in the calculation for claiming the itemized deduction for medical expenses.

So, while those with HSAs gain tax benefits from contributions made to the account, these benefits are partially offset through lower deductions for itemized medical expenses on Schedule A. We take both aspects into account in our analysis.

Onto the Analysis
We ran through a range of scenarios for our hypothetical health insurance buyer changing Adjusted Gross Income from $40,000 to $220,000 and the level of medical services purchased from $0 to $15,000 in a given year. The goal is to see whether any clear trends develop with regards to the relative merits of traditional versus HSA plans using out-of-pocket and after-tax, after HSA liquidation costs for comparison.

We present the case of an individual with $40,000 Adjusted Gross Income and Medical Services of $500 in the case below.

Under this scenario the out-of-pocket expenses during the year were similar yet the after-tax, after-HSA liquidation cost of healthcare were markedly lower under the Health Savings plan – primarily due to the lower insurance premiums required.

Putting our results in tabular form, here’s what we find.

Regardless of Adjusted Gross Income and medical services required, the HSA account proved to be the better option economically on an after tax, after liquidation basis. That said, for low service levels the HSA will require the participant to pony up more cash during the year.

Further Thoughts
Want to have your cake, and eat it too? Consider the following ideas offered by the HSA for America (quite a good resource) on their blog:

Put no money in the account, except when you incur a medical expense. This strategy allows you to legally "launder" any money used to pay medical expenses. In other words, by depositing money into your HSA, then immediately withdrawing it to reimburse yourself for medical expenses, you are making your medical expenses all tax-deductible. You may want to use this strategy if you are on a tight budget and want to keep your cash outlay as low as possible.

Fully fund the account, or at least put in as much as possible based on your budget. Take money out of the account any time medical expenses are incurred, and let the rest grow tax-deferred. This strategy will maximize your tax deduction, while making your HSA funds available to pay any non-covered medical expenses before your deductible is met.

Fully fund the account, but pay all medical expenses from a non-HSA account. Reimburse yourself for medical expenses at a later date. This strategy will allow you to maximize your tax deduction, and will also allow you to maximize the tax-deferred growth of your HSA. You can then reimburse yourself, tax-free, at any time in the future for medical expenses incurred over the ensuing years.

Furthermore, the idea of maximizing contributions to your Health Savings Account annually and waiting until the end of each year to determine the source to use in paying for your medical expenses based on your taxable situation may be of even more value. If you decide to pay out of the HSA account, simply write yourself a re-imbursement check. However in cases where you have excess cash on hand and qualify for tax deductions for amounts spent above 7.5% of your AGI it may be advantageous to pay for your medical expenses outside your HSA account.

Health Savings Accounts – A Survey of Options

In prior posts, we provided an overview of Health Savings Act signed into law by President Bush in 2004, laying out the details and mechanics of the plans relative to regular health insurance options and providing an economic comparison between the two. Our conclusion was that High Deductible Health Plans combined with Health Savings Accounts provide individuals and families a terrific way to both lower ongoing medical insurance costs and accumulate tax-free savings for future medical service needs.

In this post we take our analysis a step further, surveying the landscape of the budding Health Savings Plan account options available through a number of financial institutions. With over 1,100 banks, credit unions and brokerages offering plans, our survey isn’t exhaustive but our finding do point out the varying range of services and fees charged by HSA providers at large. We believe this can be of further economic benefit to those wishing to avail themselves of what we think will be a well-adopted and rapidly expanding health-care alternative.

The survey table can be found here.

Who are these guys anyways?

The first thing that struck us in looking at the various HSA account offerings is the plethora of startup firms dedicated solely to servicing this small, but growing, opportunity. Firms such as HSA Bank, 1^st HSA, Exante Bank, and Health Savings Administrators are all big online marketers with products that offer both savings and investment alternatives. The upside – convenience, as it’s easy to either enroll over the web or download an application. The downside – it’s impossible to know if any or all will be around in five years and, as first movers in the field they’re all looking to exploit the opportunity with fee structures that verge on embarrassing.

Fees, fees & more fees
So let’s talk about fees because the second thing that struck us in looking at HSA offerings is the wide range of fees that are currently being charged. In all, the prospective investor could be faced with possible setup fees, monthly maintenance fees, closing fees, check fees, and/or debit card fees – and that’s just for savings accounts. Add in investment management options, which can range from a select group of mutual funds to the more open platform of a linked discount brokerage account, and one may also incur mutual fund maintenance fees, as well as account minimum balance and transaction fees.

HSA-only opportunists all charge account setup fees and monthly service fees along with a variety of incidental fees.

Yet the good news is that fees are generally coming down as bigger financial institutions enter the game. Products from heavyweights BankAmerica and Wells Fargo, though limited in their investment options, charge only monthly service fees, albeit somewhat high at $3.75 to $5.

Starting Out – Go for Low Cost
Let’s face it, at their core Health Savings Accounts are meant to be backstops for our medical spending needs. As such, the first few years of having an HSA account should be dedicated to funding the account, not investing the balances. In this case you’re probably best off with a low-cost option, and among the lowest cost are those offered through local community credit unions. (We surveyed offerings from Patelco and Stanford Federal Credit Union in the San Francisco Bay area, but offerings in your area are probably comparable.) You’ll have to become a member and may have to open a traditional savings account to gain access to a chosen credit union’s HSA products, but the generous interest rates earned on the account coupled with the monthly maintenance fee savings likely more than justify the trouble.

For those wishing to forego the hassle of opening up a new banking relationship, look to your current financial institution’s offerings. Calculate the “all-in” annual cost of the offering and see how it stacks up for you. Keep in mind that for major bank’s products surveyed by us, you’ll need over $2,000 in BankAmerica’s HSA product and $900 in Wells Fargo’s before you actually earn any money, taking current interest rates paid and monthly maintenance fees into account.

Building the Nest Egg – When and How to Invest
In our opinion, one should have at least two years of possible out-of-pocket medical costs squirreled away in an HSA account before contemplating investing the balance. For individuals that likely amounts to balances of between $6,000 and $10,000 and for families its likely double. Again, your first priority is to ensure the money is there, if and when you need it.

Even with two years saved, we’d advise HSA participants invest only using lower-risk strategies, plenty of diversification stock sectors and a healthy portion (at least 40%) of income producing investments such as bonds and preferred stocks.