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Health Savings Accounts Are Part Of A Healthy Retirement

Financial wellness is becoming a well-known phrase in today’s workplace. Employees consistently rank finances as one of the primary stressors in their lives. As a result, employers are offering tools to ease their workers’ financial stress.

The health savings account is often overlooked when considering financial wellness. Most consumers are aware that an HSA provides a tax-advantaged savings component for qualified medical expenses. But less is known about the HSA’s role as a retirement planning and investment vehicle. Let’s look at the various financial benefits provided by HSAs from both a preretirement and postretirement perspective.

Preretirement

Employers have been quick to board the financial wellness train, because financially-savvy employees are more productive workers. Properly implemented and reinforced HSA programs contribute to a robust benefits package for several reasons. 

Tax advantages. HSAs allow employees to accumulate tax-advantaged funds every year as long as they are enrolled in an HSA-qualified medical plan. Unlike flexible spending accounts or health reimbursement accounts, HSA funds are portable, which means that available funds can be rolled over from year to year and from employer to employer. HSAs are owned solely by the employee, making them ideal vehicles for continuous asset accumulation.

As of 2019, the maximum annual contribution amount for individuals is $3,500 and $7,000 for families. Individuals above the age of 55 are also entitled to make catch-up contributions equaling an additional $1,000 per year. Contribution maximums increase every year and will continue to do so into the future. As a result, HSAs have emerged as an additional retirement planning instrument similar to a traditional 401(k) or individual retirement account.

When employees contribute to their HSAs via payroll deductions, the funds are accumulated on a pretax basis. This pretax advantage reduces the employee’s state and federal income tax liability while also avoiding any FICA taxes. If employers contribute to a participating employee’s HSA, those contribution amounts also are not included in the employee’s taxable income. HSA dollars are tax-exempt even at the point of withdrawal (for qualified medical expenses), creating a triple tax advantage unrivaled in any other similarly structured savings account. 

Health care savings. While health care costs continue to increase, insurance premiums are growing steadily alongside them. As a means of reducing financial obligation on both sides of the coin, employers and their employees are turning to HSA-qualified medical plans.   

Pairing a high-deductible health plan with an HSA provides dual savings for employees.  Compared to a low-deductible preferred provider organization option, HDHP premiums are significantly less expensive. This increases the employee’s take-home pay while simultaneously decreasing the dollar amount contributed by employers. 

HSAs allow employees to use the tax-exempt dollars they’ve amassed over time to pay for medical services. Employees who consistently contribute to their HSAs are putting tax-free money aside in the event of future medical expenditures. Now, even if they’re living paycheck to paycheck, as many American workers do, they have prepared themselves and their families for the economic impact of unforeseen health care costs. 

Retirement planning. Although 401(k)s have traditionally been the most popular retirement accounts, employers are quickly realizing that the tax-advantaged saving potential of an HSA is equal, if not superior, to that of the 401(k).

A recent study published by the Employee Benefit Research Institute estimates that the average American couple approaching age 65 will require nearly $300,000 to cover their health care costs during retirement. With medical costs increasing consistently alongside the average human lifespan, that number will continue to climb. These alarming statistics have contributed directly to widespread HSA adoption. Consider the following scenario:

» A 30-year-old employee opens an HSA through her employer and contributes $1,500 annually. The employer also provides an annual contribution amount of $1,000. The employee continues to add a joint $2,500 into her HSA each year for the next 15 years until she switches employers. Up until now, she has spent only 10 percent of her funds each year on qualified medical expenses, leaving $33,750 in her account. 

» Her new employer also offers an HSA but does not contribute to the employee’s accounts. By the age of 45, her income has increased, so she can afford to contribute the maximum amount of $3,450 each year (the individual maximum would have risen considerably over the years, but for comparative purposes we will use the 2018 maximum).  The employee contributes $3,450 annually over the next 10 years until she reaches age 55 and is eligible for catch-up contributions totaling $4,450 annually. She adds $4,450 each year after that until she retires at age 65.

» Over the last 20 years, she used only 15 percent of her contribution amount each year for medical expenses. As a new retiree, she will have $100,900 tax-free sitting in her HSA. Now that she is eligible for Medicare and Social Security, she will have significantly bolstered her retirement readiness through her diligent HSA contributions. 

Post-Retirement

Retirement is all too often characterized by a fear of the unknown. How much savings will I need to maintain my lifestyle in retirement?  HSAs, through their triple tax advantages and long-term savings capabilities, are helping people remove the financial stressors from their retirement years.   
Tax advantages. HSAs function a bit differently in retirement years than they do during employment.  As soon as an employee enrolls in Medicare (whether retired or not), they can no longer make HSA contributions or receive contributions from their employer. This is where the sustained accumulation of HSA dollars becomes important, because the account holder can still withdraw funds to pay for qualified medical expenses in retirement as a financial supplement to Medicare. 

HSA withdrawals for medical expenses continue to be tax-free — even while a retired employee is collecting Social Security and enrolled in Medicare. However, 401(k)s and individual retirement accounts are subject to income tax. This has contributed heavily to HSA adoption as a retirement vehicle over the last decade. 

If an employee withdraws HSA funds for a nonqualified expense before reaching age 65, they are subject to a 20 percent penalty. After age 65, employees and retirees are free to use their HSA dollars for any necessity without being penalized. These nonqualified expenses will be subject to income tax. But if the account holder is retired, these withdrawals will likely be taxed at a lower rate due to the retiree’s decreased income.

It is still recommended that HSA dollars are used exclusively for qualified medical expenses in retirement years. However, it’s reassuring to know that an HSA can be used as an added layer of financial security if nonmedical emergencies arise after the age of 65. 

Retirement health care. HSAs provide tax-free financial protection from the nearly unavoidable increase in health care expenses among the aging population. Individuals can use their HSA dollars to pay for services such as long-term care, hospice and nursing homes, as well as for home modifications such as ramps and handrails. 

Individuals are not required to begin withdrawing funds from HSAs when they reach age 70½. As a result, accountholders frequently opt to pay for minor medical expenses out of pocket during their working and early retirement years, leaving their HSA dollars untouched until later in life when the need for the funds is greater. 

Investment ability. The HSA’s best-kept secret is that accumulated funds are investable. HSA owners can grow their account balance tax-free, plus any dividends or capital gains earned are also non-taxable. Although employees typically view an HSA as a short-term solution for medical expenses, the investment component helps reinforce the HSA as a long-term savings vehicle. 

To maximize investment potential for employees, it is recommended that employers select an HSA administrator who understands an HSA’s diversified investment options. Many administrators have implemented an array of offerings, from self-directed brokerage accounts that allow HSA owners to invest in stocks, bonds and exchange-traded funds to a wide range of mutual funds available at the owner’s discretion. 

For HSA account holders who make it through retirement without using all their HSA dollars, the remaining funds can be passed on to their beneficiaries. Surviving spouses are eligible to inherit the unused balance tax-free, but any other beneficiary would be subject to taxation on the basis of the plan’s fair market value.

Sam Odishoo is an employee benefits consultant with USI Insurance Services in Chicago. Sam may be contacted at [email protected] [email protected].


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