In the early days of health savings accounts (HSAs), much of the industry focus was on educating consumers and employers on HSAs’ short-term functions — such as how to open the account, contribute to the account and pay for medical expenses.
Now that HSAs have been around for more than a decade, and given how their popularity has soared in recent years, the educational focus is shifting toward a deeper understanding of HSAs’ long-term uses and benefits, particularly as a retirement savings vehicle.
The retirement savings gap is a significant hurdle for many Americans, especially as baby boomers approach retirement age. Increased media attention and discussion of retirement savings have improved Americans’ awareness of the financial shortfall many of them will face when it comes to having sufficient retirement funds.
According to a 2015 U.S. Government Accountability Office (GAO) study, 29 percent of Americans 55 and older don’t have a retirement nest egg. Those who do have retirement funds don’t have enough money to cover essential living expenses — 55- to 64-year-olds have an average of $104,000 in savings, and those ages 65 to 74 have saved an average of $148,000.
Additionally, the specific areas of need within this gap are not widely understood by most Americans. Retirement spending covers a broad spectrum of expenses. But the greatest expenditures people face in retirement are their health-related costs.
A recent study by Health View Services estimates a healthy 65-year-old couple retiring today can expect to pay more than $400,000 (not adjusted for inflation) in health care expenses alone during retirement. That’s taking into account Medicare Parts B and D, supplemental insurance, dental and vision insurance, deductibles, copays, and other out-of-pocket health care costs. The study also predicted that these expenses will increase by an average of 5.5 percent per year during retirement, twice the U.S. inflation rate.
HSAs are gaining recognition from consumers and employers as one such tool for retirement savings due to their triple tax advantage and long-term investment capabilities. While these two benefits are becoming more widely accepted, there remains an opportunity to educate employers and consumers on additional features that make HSAs more beneficial than other retirement savings vehicles.
Although HSAs are tax-advantaged accounts, like individual retirement accounts and 401(k)s, there are five key differences between these accounts that make HSAs an ideal retirement savings vehicle.
1. Offers Triple Tax Benefits
Although this aspect of HSAs is more well-known, it is worth restating that HSAs are the only triple tax advantaged account in existence. Funds are contributed pretax and grow tax-deferred. Withdrawals are made tax-free when funds are used for IRS-qualified medical expenses. This is a significant advantage over traditional retirement options, such as a 401(k) or an IRA, which are subject to income tax when withdrawn to pay for medical expenses.
HSA funds can be used tax-free for medical expenses and require fewer post-tax funds to cover those expenses. For example, if your client has a $400 medical expense, they can withdraw $400 in HSA funds or $500 in 401(k) or an IRA funds, given a 20 percent tax rate, to pay for the medical expense.
2. Circumvents Required Minimum Distributions
Most retirement savings vehicles, including IRAs and 401(k) plans, have required minimum distributions (RMDs). This requires consumers over the age of 70.5 to withdraw a certain percentage, based on age, of funds each year from their retirement savings accounts. Not only will this create an income tax liability, but it also may have other downstream impacts. These include the possibility of triggering higher tax brackets, Medicare means testing and qualification for income-based programs for seniors.
For example, the amount that consumers pay for Medicare Part B premiums is based on their income level. Income withdrawals forced by RMDs may significantly impact the means testing and drive up premium costs. Since HSA funds are not subject to RMDs, there is a significant advantage to having funds in an HSA rather than another retirement vehicle such as an IRA or a 401(k).
3. Pays for Medicare Premiums
One of the most powerful advantages an HSA offers is the ability to pay for Medicare premiums on a tax-qualified basis. Given that most Americans could end up paying these costs for years, if not decades, this use may be one of the greatest potential health care savings opportunities in America today.
Although Medicare Part A does not have a premium cost, other Medicare premiums (such as for Parts B and D), along with any out-of-pocket health care costs, can be made tax-free and penalty-free. Paying for Medicare premiums with HSA funds can save your client a considerable amount of money compared to paying out of pocket or using another retirement savings vehicle where the funds will be subject to income tax.
For example, just considering Part B alone, a Medicare Part B enrollee with a $100,000 income level will pay at least $187 per month in premiums for the next 15 years, totaling $33,750. Assuming an income tax bracket of 20 percent, the retiree would need to withdraw $40,500 from their 401(k) to cover their lifetime Medicare premiums. By using an HSA to pay these premiums, the retiree will save $6,750.
4. Reimburses Medical Expenses at Any Time
HSA funds can be used to reimburse medical expenses incurred anytime after the HSA is established, even in retirement, many years after an expense has occurred as long as your client documents their expenses. This means that your client can continue to accumulate savings in their HSA, while paying for medical expenses out of pocket and building up funds for future reimbursement to take at a later date — without any impact on their taxable retirement income.
5. Covers Non-medical Expenses With Income Tax
HSA funds don’t have to be used to pay for medical expenses. For those age 65 and older who do not require all of their HSA funds to cover health care costs, the funds can be withdrawn for any reason without penalty. However, HSA distributions not used to pay for IRS-qualified medical expenses are subject to income tax, similar to traditional 401(k) and IRA distributions.
Building a Holistic Retirement Strategy
Incorporating HSAs into your clients’ retirement strategy does more than help grow a larger nest egg. It gives your clients a set of funds that works smarter and more efficiently than other retirement savings vehicles to save them money.
About 20 percent of privately insured Americans are covered by an HSA-qualified health plan, according to Kaiser Family Foundation. In addition, 53 percent of firms with 200 or more employees offer a high-deductible health plan with a savings option (HSA or health reimbursement account) as a health plan option. So whether or not you are working actively within the HSA environment, it is likely your clients have considered or are considering an HSA.
By incorporating an HSA discussion into your value stream, you can provide your clients with useful and relevant information, differentiate yourself from other advisors, and reinforce your crucial role in the benefits process.