Wealth Planning Your Employee Benefits
When I arrived at my first real job out of college, there was a lot of handshaking and nodding, but I specifically remember being pulled aside by the human resources administrator mid-day to review the company’s employee benefit package and complete my paperwork. Amid the jargon, I heard a few recognizable words: “health insurance,” “retirement” and “we recommend.”
Our conversation led me to enroll in the most popular plan among employees. And frankly, I was happy for her guidance. I could more easily land a rover on Mars than calculate the right type of insurance plan for my personal needs at age 22. Was there a class I missed in college?
I’ve been in the workplace for over 20 years now, and open enrollment still feels daunting. It’s that time of year again, and you’ll likely be receiving an email from your company’s human resources department about open enrollment for employee benefits soon.
Reality is few people have much comfort or skill in determining an appropriate benefits plan that aligns with their personal needs. But keep in mind that job benefits are an essential part of wealth planning. The two most important benefits — medical insurance and retirement savings — help to protect and strengthen your financial picture. Once you understand the basics, you might actually enjoy crafting a benefit plan that optimizes the offerings provided by your employer and fully meets your needs.
Sorting through health insurance
Choosing a health plan is one of the biggest decisions you’ll have to make as it not only impacts your near-term cash flow, but it could also have implications on your long-term physical and financial health. When determining the appropriate type of coverage, you’ll need to consider several factors:
- Premium cost
- Maximum out-of-pocket expenses
- Your own and your family’s current health issues
Everyone will have different priorities, and since no two employee benefit packages look alike, you’ll have to do a little homework. Conduct a personal inventory of your needs and wants and then evaluate your plan options to determine which makes the most sense. For example, if you take a specific medication, one plan might cover more of the prescription cost than another plan. Some plans cover acupuncture and mental health visits while others do not. Plus, it’s practically guaranteed that your priorities will shift over time.
Understanding the lingo
Before you analyze insurance options, it’s important to understand these key terms:
- Premium — The cost to carry a health care insurance policy. It’s typically deducted from your paycheck each pay period and may be subsidized by your employer. You’ll owe this amount for coverage alone, regardless of whether you use services.
- Co-pay — The amount you’re required to pay for covered health care services. Co-pays are typically a fixed cost for the services you incur — inexpensive for primary care and a little higher for specialized services (e.g., $20 and $50, respectively).
- Deductible — The amount you’re required to pay out of pocket for covered health care expenses before the insurance company will begin paying. This could be an important variable in choosing a plan. Some plans do not have deductibles, while others may have two separate deductibles for medical care and prescription medication. Deductibles reset each year.
- Co-insurance — This is a percentage of health care costs that you’re expected to pay after you’ve reached your plan deductible. For example, if your plan covers 80% of qualified medical care, you’ll pay 20% of the billed amount. Co-insurance within your network of providers is usually cheaper than co-insurance off network (e.g., 20% versus 40%). You’ll continue to pay coinsurance until you reach the annual out-of-pocket maximum.
- Annual out-of-pocket maximum — Since health care costs quickly add up, policies include a maximum threshold for your out-of-pocket expenses. After you meet the out-of-pocket maximum for the year, all remaining covered care requires no further payment from you.
- Network — Some plans require you to seek care within their network of service providers, a.k.a. doctors. This allows the insurance companies to offer you comprehensive care at a very attractive price because all service costs have been negotiated with the doctors in the network. When plans allow you to seek out-of-network care, you’ll incur higher costs for treatment.
Now, here are the three most basic types of coverage you’ll see:
- Health Maintenance Organizations (HMO) — An HMO typically has no deductibles, offers low and fixed co-pay fees, and has little to no paperwork. But they have greater restrictions on who you can see and services you can receive. This is an attractive plan if you have few medical needs and want a low premium.
- Preferred Provider Organization (PPO) — Gives you greater choice on health-care providers and services, but you will probably pay more out of pocket through higher co-insurance rates. This is a great plan if you want flexibility in who provides your care and don’t mind paying a little extra for the freedom.
- High Deductible Health Plan (HDHP) — These policies have the lowest premiums, but you’ll have to pay a much higher deductible up front — it can be in the thousands — before co-insurance coverage kicks in. If you’re looking to optimize your finances and have cash reserves to cover higher medical costs, this plan offers a great saving opportunity when paired with a Health Savings Account (HSA).
HSAs: An investment in your health
You must be enrolled in an HDHP to contribute to an HSA. When you enroll, you’ll specify how much money you want to contribute to this fund during the year. The maximum amounts for 2019 are $3,500 for individuals and $7,000 for families. Contributions will come out every paycheck, so when starting an HSA, it’s important to have cash reserves set aside until your HSA balance builds up.
An HSA provides a powerful opportunity for long-term savings. Here are the basic benefits of these plans:
- Dollars that you contribute to the plan go in pre-tax — you won’t pay federal income taxes on it. Some states allow tax-free contributions as well. Think of it this way, medical care paid through your HSA account provides a discount equal to your marginal federal tax rate (as high as 37% in 2019).
- You can invest the dollars you’ve contributed in mutual funds for long-term growth. HSAs comprise of two separate accounts — one holds cash for near-term expenses and the other holds investable dollars.
- When you use your HSA to pay for qualified medical expenses, distributions from the plan are not taxed. That’s right, dollars aren’t taxed on the way in or the way out.
- Left-over funds in your account rollover year after year. So if you don’t need much health care today, you should have a nice savings account for when you get older and will likely need more services.
Remember, not contributing enough to your HSA could leave you vulnerable if you have unexpected medical expenses. Some people with HDHP plans don’t seek medical care because they don’t have enough funds to pay the high deductible.
While saving money is great, consider the greatest benefit of some plans is the simple freedom to choose your own care provider. Having fewer restrictions on your health-care decisions may easily outweigh the affordability of a more restrictive plan. That’s why your lifestyle preferences and current health-care needs play the most important part in choosing a plan.
Weighing retirement plans
Employer-based retirement plans are a great way to save for retirement, allowing you to put aside more money, up to $19,000 in 2019, than an IRA which caps out at $6,000 this year. If an employer offers a retirement plan, it’s typically a traditional 401(k). But some employers are starting to offer Roth 401(k)s, which offer attractive tax advantages.
401(k) plans allow you to pull money from each paycheck and deposit it into an investment account. As an added bonus, many companies also offer a match on your savings. For instance, if your employer offers to match 50% of the first $10,000 you defer to the plan, they’ll contribute up to $5,000 to your retirement fund. This is an important part of your compensation and as a general rule, you should try to set aside enough to get the maximum match.
Note that in order to retain employees, some companies will make their match amount vest over a certain amount of time. This means that if you leave the company before the vesting period is over, they can keep the portion of their contribution that hasn’t vested. They can never keep any of the contributions you made or the growth of those contributions.
There are two main types of 401(k)s:
- Traditional 401(k) — With this retirement savings vehicle, you can contribute a portion of your paycheck pre-tax. This can be a powerful tool if you can contribute enough to lower an entire tax bracket for the year. The catch is that Uncle Sam will eventually want his money. When you are 70½ , you will have to start drawing a percentage of the account balance every year, regardless of whether you need the money. The withdrawal is called a Required Minimum Distribution (RMD) and will be taxed at ordinary income rates (which may be lower in retirement).
- Roth 401(k) — This is a newer offering to the employee benefits pool. The concept of a Roth 401(k) is much the same as the Roth IRA. The way the Roth 401(k) differs from the traditional is that the Roth contributions are all after-tax dollars, meaning your contributions will still be counted as income for the year. But the benefit is that the contributions grow tax-free forever — no income or capital gains tax will be due upon distribution. You also won’t have any RMDs in retirement.
See To Roth or Not to Roth, to help you decide which option is best for you.
If you’re a public employee or work at a non-profit, you may have different options:
- 403(b) plans (a.k.a. tax-sheltered annuity plans) — These plans are like a 401(k) plan, but they are for tax-exempt organizations like 501(c)(3) non-profits and certain public schools and colleges. The major difference is that the investment options provided for 403(b) plans are legally restricted to mutual funds and insurance annuity contracts.
- 457 plans —Typically, 457s are offered to government employees. An advantage of the 457 is that contributions to this plan do not reduce your allowance for contributing to any other 403(b) or 401(k) plan your employer offers. The drawback of the 457 is that unlike the other options, matches made by the employer count toward the yearly contribution maximum.
An interesting new feature being added to retirement savings plans is auto enrollment. This allows companies to automatically enroll eligible employees in their savings plan at contribution rates set forth in the plan documents. Employees must now actively choose to not participate. The idea appeals to the sense of “path of least resistance” or forced saving. The hope is that the administrative hurdle long cited as reason to put off saving will be turned around. Now, employees will find they don’t want to go to through the trouble of turning off their contributions. Be sure you understand if your plan will be doing this for you and factor it into your monthly budget. You will still have the option of adjusting the amount you defer.
Investing for your retirement
Once your employer-sponsored retirement account is open, you’ll be provided a list of investment funds that you may buy with your savings. The first thing to consider when deciding what to invest in is determining your risk tolerance for your retirement funds. How would you feel if your portfolio dropped 20% in value?
Your risk tolerance will inform your asset allocation choice. Asset allocation is a measure of how much of one kind of investment you have as opposed to another, typically stocks and bonds. The more stocks you take on, the more risk and volatility you will experience. If you don’t plan to retire for another 30 years, it might make sense to hold a higher allocation (60% or 80%) to stocks (equities) in the account. If you know that retirement is closer on the horizon and you’re going to need those funds soon, you may want to consider an allocation with more bonds (fixed income) than equities.
It’s rare to see individual stock and bond holdings. This creates access to volatility that employers don’t like to be associated with. Therefore, the majority of what you’ll find in your plans will be mutual funds and occasionally ETFs. You will be able to set your asset allocation by combining individual funds or choosing a target date fund, which are described below.
Visit Morningstar.com to research each of the funds offered in your employer plan. The site will provide the fund cost, management fees (beyond the purchase price of the fund), its top holdings and its historical performance.
Another potential investing option will be target date funds. These are mutual funds that are actively managed to automatically re-allocate investments based on your anticipated retirement date. For example, if you buy a 2060 target date retirement fund today, you’ll get a fund with a much riskier allocation than a 2025 target date fund. As time goes by, the fund will change its allocation to become more conservative as you approach retirement.
Taking the time to make the right decision
As you can see, there’s a lot to consider for just health care and retirement benefits alone. Adding to the overwhelming choices, you may also be offered life insurance, disability insurance, flexible savings accounts for day care and health care, and more. But it’s really worth your time to read the materials and examine your options. With careful consideration and guidance (a wealth planner can help), you can use these valuable benefits to get steps ahead on a secure wealth plan.
Important disclaimer: Individual health care policies may differ from what is described in this article.