How to Save $4,000 in Your Graduation Year – Part 2: Insurance

[This is a guest post from Bogleheads investment forum participant Bob’s not my name as a follow-up to his previous post How to Save $4,000 in Your Graduation Year — Part 1: Taxes.]

In Part 1, we looked at the weird stew of education credits and deductions the government has cooked up. The government’s meddling hand is evident in Part 2, as well.

Health insurance and FSA: save up $1,000 in your graduation year and $1,700/year thereafter

You’ve graduated from college, moved into your own apartment, and started your new job. You thought you were all grown up, but the Affordable Care Act has made independent adult children up to age 26 eligible for health and dental coverage under their parents’ insurance even if they are eligible for coverage under another plan. You may want to cut the cord with your parents, but that’s hard to do when there is up to $5,000 of savings to be had.

You’ll need to discuss this with your parents. Some group plans aren’t required to offer this until 2014. Some plans may be unsuitable for your geographic location. And some plans may have a premium structure that makes this unattractive.

Where I work, the health and dental insurance premiums are the same whether I insure one child or ten. Since I have one kid still at home, this effectively means that my older kids, who live far away and make more than me, can get “free” health and dental insurance, where “free” means I pay through the nose willy nilly and they pay nothing at all.

Health insurance premiums for a single adult covered by an employer may be about $1,400/year. Since premiums deducted from your pay are exempt from income and payroll taxes, this is a savings before taxes (whereas the tax savings discussed in Part 1 are net). However, if you invest that $1,300 (net after payroll taxes) in your traditional 401k or IRA you are deferring income taxes on it for a half century.

If you graduate around your 22nd birthday, you can play this game for four years and make $5,000 of extra contributions to your retirement plan. What happens when you turn 26? Your parents’ plan might voluntarily cover you through the rest of the calendar year. If it doesn’t, you can switch to your own employer’s plan. Note that “loss of coverage” is a “qualifying event” for a change in your enrollment in the middle of the plan year.

Things get weirder: Because out-of-pocket expenses not covered by insurance (co-pays, deductibles, glasses and contacts) are covered by Flexible Spending Account reimbursements, you might think of insurance and FSA as being complementary and therefore coordinated, but they’re not.

Non-dependents, even if covered by their parents’ health insurance under the new rules, are not eligible for their parents’ FSA. So you’re going to want to set up your own FSA at your new job even though you’ll be waiving health and dental insurance. The FSA is a very good deal because it allows you to pay for medical expenses with gross salary, dodging federal income tax, state income tax, Social Security tax, and Medicare tax. It’s discussed more fully in this thread in the Bogleheads forum.

Car insurance: save a mysterious amount

It’s increasingly common for college graduates who take new jobs in urban areas to eschew personal vehicles. This avoids the massive expense of buying a car just as you’re starting out. If your situation allows this, do it. Putting off buying a car for even one year is a major boon to your personal finances.

If you don’t own a car, do you need insurance for those times when you do drive? Zipcar includes insurance. Other rentals generally allow waiver of coverage, so the question is: do you need to take the overpriced rental agency coverage?

My insurance agent first told me that my non-dependent kids would continue to be covered by my policy, until I pointed out that the policy clearly says otherwise (only resident relatives are covered).

In a second conversation, another person at the agency told me that I should still keep my kids on my policy even though doing so provides no additional coverage (they’re still not covered for rentals, and they would be covered in any case for driving our vehicles when they visit, since any driver is) because by having existing and continuous coverage they will save hundreds of dollars in premiums when they eventually get their own vehicles and insurance. This seems like utter nonsense … and therefore credible.

Nonetheless, I was inclined to say no way, that’s their problem, until the agent told me that the premium increment for keeping a 25-year-old on my policy is only $30/year. Younger drivers cost a lot more, but the incremental cost drops precipitously with age when you have more than two insured drivers but only two cars.

So, like health insurance, this is something you should discuss with the parents from whom you thought you were now independent. Whether it’s a good idea to pay a premium increment for no coverage will depend on your age, how long you intend to go carless, and other factors.