Tax Refund Challenge: When Things Don’t Go As Planned
Last week, I was scrolling through travel websites in search of a family vacation. It’s been a while since we’ve been able to pack up and go anywhere just for fun, so this is something that I’ve been thinking about a great deal. It just so happens that my wanderlust coincided with our tax refund challenge at Bankable. With tax season opening today, we asked our writers to consider what they would do if Uncle Sam handed over a big fat check in an amount equal to the average refund check last year ($2,782, as of 3rd quarter 2017).
To be fair, I never see that kind of refund check. I’m usually on the opposite end of that equation: writing a check. But for the challenge, I began thinking about how I would spend a refund check if I received one, and I landed on vacation.
While I’m really good at finding deals, once you add in airfare and hotel (not to mention food and other transportation), you’re already close to the $2,000 mark even for domestic travel. And you can forget about an amusement park like Disney where tickets alone would run nearly $1,000. The secret, I figured, was to keep searching.
But that all changed on Friday night. A few hours before midnight, I received a text that my daughter was on the way to the hospital to get an X-ray for a possible sprain. She was at her hockey game and collided with another player on the ice. It turned out that it wasn’t a sprain: It was a break. Additionally, because there’s a little bit of space at the break, she has to see an orthopedist to determine whether she’ll need surgery.
Suddenly, that family vacation wasn’t tops on my mind. I discovered another way that I’d spend my imaginary refund check: paying medical bills.
Medical bills are a major concern for many families. According to a report by the Kaiser Family Foundation, approximately one-quarter of Americans ages 18-64 report having problems paying medical bills, with nearly half of those saying that the bills had a “major” impact on their families.
I know what you’re thinking: The report probably focused on the poor and uninsured. That’s not the case at all. In fact, the survey shows that while insurance may protect people from having medical bill problems in the first place, “once those problems occur the consequences are similar regardless of insurance status.” The report also found that, among those who had problems paying medical bills, “those with higher incomes are just as likely to report that the bills had a major impact as those with lower incomes.”
At first blush, that might not make sense. Why would a higher-income family with insurance struggle to pay medical bills? As it turns out, I know exactly what they’re talking about.
According to Kaiser, among those with private health insurance, those in high-deductible plans are more likely than those in lower-deductible plans to say the bills had a major impact on their family. That’s because those with high deductible plans typically report having higher bills on average: About two-thirds (64%) of those in high-deductible plans have medical bills of $2,500 or more.
I have a high-deductible plan. For 2018, my family annual deductible is $3,600. Under the plan, “no one in the family is eligible to receive Benefits until the family Annual Deductible is satisfied.”
So that trip to the ER this weekend? We will pay for it out of pocket until we hit $3,600. With ER care and radiology, I know we probably hit that amount in one day, or shortly after. Once that happens, we’ll pay a 20% coinsurance up to our out-of-pocket maximum. Our out-of-pocket maximum is $5,600 per calendar year but that actually sounds better than it is: The out-of-pocket costs do not cover the annual deductible or charges for non-covered health services (including, among other things, out-of-network coverage). It also doesn’t count health insurance premiums. In 2016, following an unexpected surgery, our family’s medical expenses totaled nearly $20,000.
On the plus side, medical expenses are deductible for taxpayers, like me, who itemize. However, they are only deductible to the extent that they exceed the floor – and that can be pretty limiting. A floor is the opposite of a cap: it’s a number under which you cannot deduct expenses. For 2017, the floor is 7.5% of adjusted gross income (AGI) but for 2016, the floor was 10%.
Let’s do the math. Let’s assume your AGI was a healthy $100,000 and your medical bills were $20,000. In 2016, you could deduct $10,000 on your Schedule A ($20,000 in medical expenses less the $10,000 floor (10% of your $100,000 AGI)). In that example, even though medical bills ate up 20% of pre-tax income ($20,000), deductible expenses counted for just 10% of pre-tax income. Remember that deductions are a dollar-for-dollar reduction in taxable income, not tax due (unlike credits). Assuming a tax rate of around 25% in this example, that medical expenses tax break is worth about $2,500 in tax savings (25% rate times the $10,000 deduction) – even though you might be out-of-pocket $20,000. It is something but not exactly a financial salve.
(NOTE: As a result of the TCJA, the floor for 2019 through 2025 is 10%.)
Because the tax savings through itemizing can be limited, taxpayers who have a high-deductible plan often use a Health Savings Account (HSA) to pay for expenses. With an HSA, you may be able to claim a tax deduction for contributions you make to your HSA – even if you don’t itemize your deductions on Schedule A. And any contributions from your employer? They’re not considered income for federal income tax purposes: They’re tax-free.
Not only are your contributions tax-free, those HSA funds also grow tax-free. And when you take them out? Distributions for qualified medical expenses (including dental and vision expenses) are not taxable for federal income tax purposes.
How does all of this translate into real life? Even with tax breaks, it can still be a struggle. According to the Kaiser report, problems paying medical bills can result in major financial difficulties, sometimes ending in bankruptcy – even for those with health insurance. And even when medical bills are manageable over time, families have to rearrange their finances in order to cover them. That’s true even for those of us with health insurance: we’re more likely than the uninsured to put off vacations or major household purchases (77% versus 64%); cut back spending on food, clothing, or basic household items (75% versus 62%); use all or most of savings (63% versus 51%); increase credit card debt (38% versus 24%); or take out of long-term savings (31% versus 17%) in order to pay medical bills.
I realize that I am fortunate to be in a financial situation where I have health insurance and I can pay for my family’s health care, but that doesn’t mean that it’s easy. So that fantasy vacation that I’d pay for with my non-existent tax refund check? I would have pushed it off to pay medical bills. The plus side? Our medical bills will eventually get paid and my daughter should be back on the ice in a few months.
