Buying Health Insurance Vs the Paying the Penalty: Doing the Math

There's a lot to consider when calculating the real financial impact of buying health insurance vs paying the penalty for being uninsured.. Image © Cevdet Gokhan Palas/Getty Images

If you’re trying to decide whether you should buy health insurance or pay the Affordable Care Act's  tax penalty for being uninsured, you’re probably wondering how each option will affect your budget. If you compare only the cost of buying health insurance with the cost of paying the tax penalty, most people will find that it’s cheaper to pay the tax penalty. See why in “Which Costs Less, Health Insurance or the Tax Penalty?

However, the decision’s impact on your budget goes beyond paying your health insurance premiums or paying the tax penalty. Since having health insurance is likely to affect how much you pay for health care, the money you save by having lower health care expenses will partially offset the amount you spend on health insurance premiums. If you lower your medical expenses a lot by having health insurance, it could make your yearly budget look better when you include health insurance than when you pay the tax penalty.

In addition, health insurance is tax deductible for some people. If you're one of those people, the tax deduction will partially offset the cost of your health insurance premiums.

How do you determine how each choice will impact your budget? You can’t know for sure, because you can’t know what kinds of health care expenses you’ll incur in the upcoming year. However, you can make an educated guess based on your general state of health and your past health care expenses.

Doing the Math—What to Include

Doing the math to figure this out will take at least the better part of an afternoon, so tackle it when you have the time to devote to it. You’ll compare these two complex figures:

  • The cost of the tax penalty plus the cost of paying all of your medical expenses without the help of health insurance.
  • The cost of health insurance premiums plus the decreased cost of health care expenses once you’re insured.

Crunching the Numbers Part One: Cost of the Penalty Option

  1. Determine if you’re eligible for an exemption from the penalty. You’ll find a list of situations that exempt you from having to pay the tax penalty in “Can You Get a Health Insurance Exemption?” If you think you might be eligible for a hardship exemption, see more specific details about qualifications for it in “How To Get a Hardship Exemption From Health Insurance.” If you’re eligible for an exemption from the tax penalty, you can skip step two and move on to step three.
  2. Calculate your tax penalty. This isn’t hard, but you’ll need a good estimate of your yearly income. Learn how in “How Much Is the Health Insurance Penalty for an Individual?” or “How Much Is the Health Insurance Penalty for a Family?
  3. Estimate your medical expenses based on a prior year’s expenses. Make a list of your health care expenses along with an estimate of how much each item costs. Don’t include things that health insurance won’t pay for like over-the-counter medicines or cosmetic treatments since you’ll have to pay for those things whether or not you have health insurance. Do include things like prescription drugs, physician visits, and blood tests. If you’re female, include birth control, your yearly mammogram, and your well-woman exam. Save this list, you’ll use it again later
  1.  Add together the penalty amount you calculated in step two (unless you’re eligible for an exemption) and the health care expenses you calculated in step three. Set this figure aside; you’ll need it for part three.

Crunching the Numbers Part Two: Cost of the Health Insurance Option

  1. Determine the cost of health insurance.
    • If you’re considering health insurance provided by your employer, your human resources or benefits office can tell you how much you’ll pay for health insurance. If you’re offered more than one health plan option, choose the plan that you like best and write down how much it will cost for an entire year’s coverage. Also, note the deductible amounts, copayments, and coinsurance.
    • If you’re considering an Obamacare plan, start with Choose your state from the drop-down menu. If your state runs its own health insurance exchange, will direct you to it. You’ll have to input financial and demographic information in order to find out if you’re eligible for a government subsidy that will pay part of your health insurance premiums. When the exchange shows you different health plans and their prices, choose the plan you’re most interested in and write down how much it will cost for an entire year.
  2. Using the list of medical expenses you made in part one, calculate how much medical care would cost if you were to buy the health plan you’re considering.
    • Most health plans must pay 100% of the cost of preventive care without requiring deductibles, copays, or coinsurance from you. So, scan your list of health care expenses for preventive care items like your yearly physical exam, well-woman exam, birth control, and screening mammogram. Cross them off of your list.
    • For the remaining items on your list of health care expenses, your health insurance will pick up part of the tab, but it won’t pay 100% of the cost. Known as cost-sharing, you’ll be expected to pay part of the cost, too. Estimate your cost-sharing amount for the remaining non-preventive services on your list of health care expenses. Learn how in “How To Estimate Your Health Insurance Cost-Sharing Expenses.”
  3. Add your estimated cost-sharing expenses to the yearly cost of health insurance premiums.

Crunching the Numbers Part Three: Comparing the Options, Health Insurance Vs the Tax Penalty

Compare the figure you calculated in part one with the figure you calculated in part two. If part one resulted in the smallest number, paying the penalty tax is likely to be the most budget-friendly option for you. If part two resulted in the smallest number, buying health insurance will likely be the most budget-friendly option for you.

A Word of Caution

Ultimately, the reason for having health insurance isn’t to pay for a $30 flu shot. It’s to protect you from devastating financial losses in the case of significant medical problems. While you may save a few hundred or even a thousand dollars a year by forgoing health insurance and paying the tax penalty instead, those savings pale in comparison to the losses you’ll face if you have to pay $400,000 out-of-pocket for a bone marrow transplant because you didn’t have health insurance.

Although premiums, deductibles, copayments, and coinsurance may seem like an awful lot of money when you add them together, remember that you’re protected by your health insurance policy’s out-of-pocket maximum. After you’ve paid enough in cost-sharing to have reached your out-of-pocket maximum, most health insurers will cover 100% of the cost of medically necessary, in-network care for the rest of the year.

If you need that $400,000 bone marrow transplant but your health insurance requires 20% coinsurance, you won’t pay 20% of $400,000. You’ll only pay enough to meet your out-of-pocket maximum, and then you’ll stop cost-sharing until next year.  The highest out-of-pocket maximum allowed for Obamacare plans in 2015 is $6,600 for an individual or $13,200 for a family.

I’m an RN who specializes in health insurance. I believe that having health insurance coverage is generally a wise choice. I’m not a financial planner, CPA, or other financial professional. As such, the information presented in this article shouldn't be considered financial advice. Seek the advice of an accountant or financial planner before taking action.

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