What is the term used for the amount of money for which the patient is responsible before insurance coverage kicks in?

What Are Out-of-Pocket Expenses?

Out-of-pocket expenses refer to costs that individuals pay out of their own cash reserves. The phrase is most often used to describe an employee's business and work-related expenses that the company later reimburses. It also describes a policyholder's share of health insurance costs, including money spent on deductibles, copays, and coinsurance.

Key Takeaways

• An out-of-pocket expense is a payment you make with your own money even if you are reimbursed later.
• Business and work-related out-of-pocket expenses are usually reimbursed by the employer.
• In terms of health insurance, out-of-pocket expenses are your share of covered healthcare costs, including the money you pay for deductibles, copays, and coinsurance.
• Health insurance plans have an out-of-pocket maximum that caps the amount you pay each year for covered healthcare expenses.
• Some out-of-pocket expenses can be deducted from your income taxes.

Understanding Out-of-Pocket Expenses

Employees often spend their own money on business-related expenses. These out-of-pocket expenses are typically reimbursed by the employer, using a specific, company-approved process. Common examples of work-related out-of-pocket expenses include airfare, car rentals, taxis/Ubers, gas, tolls, parking, lodging, and meals, as well as work-related supplies and tools.

The term out-of-pocket expenses is also used in health insurance, wherein it refers to the portion of the bill that the insurance company doesn't cover and that the individual must pay on their own. Out-of-pocket healthcare expenses include deductibles, copays, and coinsurance.

Health insurance plans have out-of-pocket maximums. These are caps on the amount of money that a policyholder can spend each year on covered healthcare expenses. The Affordable Care Act (ACA) of 2010 requires all group and individual plans to stay within annually updated guidelines for out-of-pocket maximums unless given special exceptions for legacy plans.

For 2021, the out-of-pocket limits are $8,550 for individual coverage and $17,100 for family coverage. For 2022, the out-of-pocket limits will increase to $8,700 for an individual and $17,400 for a family. Though plans can't have out-of-pocket maximums that exceed these limits, many offer lower maximums.

Out-of-Pocket Maximums vs. Deductibles

With health insurance, the deductible is the amount you pay each year for covered costs before insurance kicks in. When the deductible is met, the policyholder "shares" the costs with the insurance plan through coinsurance. With an 80/20 plan, for example, the policyholder pays 20% of costs, while the plan picks up the remaining 80%.

The amount you pay for coinsurance—as well as your copays and deductible—all count toward the out-of-pocket maximum for the year. When you reach your out-of-pocket maximum, the plan pays 100% of covered costs for the rest of the year.

Some plans have higher deductibles than others. Typically, the lower the premium you pay, the higher the deductible, and the higher the premium you pay, the lower the deductible.

High-Deductible Health Plans (HDHPs)

A high deductible health plan (HDHP) can save you money in the form of lower premiums. You also may get a tax break on medical expenses through a health savings account (HSA). According to Internal Revenue Service (IRS) rules, an HDHP is a health insurance plan with a deductible of at least $1,400 if you have an individual plan—or a deductible of at least $2,800 if you have a family plan. For 2022, the upper limits of an HDHP have changed. Out-of-pocket costs may not exceed $7,050 for an individual or $14,100 for a family.

An HDHP provides 100% coverage for preventive services from in-network providers before you meet your deductible because of ACA requirements.

For individuals who don’t anticipate many medical expenses for the upcoming year, it makes sense to minimize premiums and choose an HDHP because it is unlikely that you will meet the high deductible. However, if you do anticipate significant medical expenses, a plan with a lower deductible but a higher premium would be preferable so that the insurance kicks in earlier.

An HDHP allows the holder to contribute to an HSA. Policyholders in the 24% federal tax bracket and who incur $3,000 in medical expenses can use an HSA to pay for them with pretax dollars. A medical expense of $3,000 in post-tax dollars could cost $4,000.

When deciding whether to choose a plan with a high or low deductible, estimate your likely medical expenses for the year and research the premiums, deductibles, and out-of-pocket maximums for the available plans.

Examples of Out-of-Pocket Expenses

Here's an example of work-related out-of-pocket expenses. Assume an employee has a meeting with a potential client. The employee spends $250 on airfare, $50 on Uber rides, $100 on a hotel, and $100 on meals—all charged to their own credit card. After the trip, the employee submits an expense report for $500 for their out-of-pocket expenses. The employer then issues a reimbursement check for $500 to the employee.

One example of out-of-pocket health expenses is prescription medications. Many health insurance plans cover prescriptions, but the amount you pay depends on your deductible responsibilities. If you have not met your deductible amount, you will have to pay out of pocket for any prescription medications until you have. However, some health insurance plans allow generic drugs to be purchased at discounted rates regardless of whether the annual deductible has already been met. Some medical plans have a combined medical and prescription deductible.

Here's an example:

Lisa has a $2,500 combined deductible. She has already paid $2,350 in out-of-pocket expenses toward her deductible and now needs to purchase $150 worth of prescription medicine. Lisa's out-of-pocket cost will be $150; however, her combined deductible will now be met for the year.

When you have met your deductible, you may still have to pay an amount for each prescription. For example, a plan might state that you must pay $10 for each refill of generic drugs or prescription medicine, meaning your out-of-pocket cost will be $10 for each prescription.

Other Types of Out-of-Pocket Expenses

In the real estate industry, out-of-pocket expenses refer to any expenses above and beyond the mortgage itself that the buyer incurs through the sales process. These costs vary depending on the property and real estate laws in the area, but they typically include the cost of a home inspection, appraisal fees, and escrow account deposits as well as closing costs, which can include loan origination fees, attorney fees, and property taxes.

Out-of-Pocket Expenses and Tax Returns

Some out-of-pocket expenses can be deducted from your personal income taxes. For example, income tax deductions are still available for expenses related to charitable donations and unreimbursed medical expenses. Since the passage of the Tax Cut and Jobs Act (TCJA) of 2017, however, individuals can no longer deduct unreimbursed business expenses.

Though tax deductions don't represent a direct reimbursement, there is an ancillary benefit to them because claiming these expenses as a deduction can lower your tax burden for the year.

Moving and Relocation Expenses

Moving expenses, according to the IRS, are costs the taxpayer incurs as a result of relocating for a new job or transferring to a new location. However, the TCJA eliminated the deduction of moving expenses for tax years 2018 through 2025, except for members of the military on active duty who move as the result of a military order.

Members of the armed forces can use IRS Form 3903 to claim the cost of moving expenses as federal income tax deductions.

Active-duty members of the U.S. military can deduct moving expenses if they incurred them in response to a military order that requires a permanent change of station. The types of expenses that qualify are moving expenses—such as the cost of packing, crating, hauling a trailer, in-transit storage, and insurance—storage expenses, and travel expenses.  If the government provides and pays for any of your moving or storage expenses, you should not claim these expenses as a deduction on your taxes.

What Does Out-of-Pocket Mean?

An out-of-pocket expense is a payment you make with your own money even if you are reimbursed. It could be a business expense, such as paying for a flight that is reimbursed by your employer, or a health expense that goes toward your health insurance deductible.

What Is the Difference Between a Deductible and an Out-of-Pocket Expense?

Both a plan’s deductible and out-of-pocket limit represent points at which the insurance company pays for all or some of your care. However, they are two different things. Healthcare plans have two primary cost components: the premium and the deductible. Your deductible is the amount of money you have to pay yourself for covered medical expenses before your insurance company starts helping with costs. The out-of-pocket limit is the maximum amount of your own money you will have to pay for care during the year. The limit is the sum of your deductible plus coinsurance plus copayments (if your plan has them) up to a total dollar amount.

What Is Not an Example of an Out-of-Pocket Expense?

Out-of-pocket costs include deductibles, coinsurance, and co-payments for covered services plus all costs for services that aren't covered. The premium you pay for your healthcare plan is not an out-of-pocket expense.

Is It Better to Pay Out-of-Pocket or Use Health Insurance?

It is tempting to choose to pay out-of-pocket and pay lower premiums if you think you will not have considerable medical expenses. But this could become expensive if you do end up needing substantial medical care. Still, if you’re someone who doesn’t expect to spend thousands of dollars on medical expenses early on in the year, you might not meet your out-of-pocket maximum, regardless of whether it’s low or high.

The Bottom Line

Out-of-pocket expenses can quickly add up and exceed anticipated amounts. Where a healthcare plan is concerned, it is wise to estimate what your healthcare costs may be each year before deciding on a low deductible-high premium or high deductible-low premium plan. Also consider that your healthcare needs will change as you age or when you decide to start a family, which will affect your costs and the amount of out-of-pocket deductible you can afford.

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