By Thomas A. McCoy, CLU

Convincing today's workers to save more for retirement isn't easy. Young employees have the most to gain from planning prudently for retirement, but it's a tough sell to educate them about financial security issues that are decades into the future. They are understandably more focused on student loan debt and new family obligations. Eventually members of the Millennial and Gen X generations may be influenced by the angst that the generations ahead of them experience as they head into retirement, and vow to avoid their own late-in-career panic by boosting their retirement plan contributions.

The generation prior to the Boomers had its own financial struggles, including a childhood shaped by the Great Depression. Many in that generation started working shortly after World War II, and by the time they entered retirement, they did so with more confidence than their offspring who are reaching retirement age now. That former generation was more widely covered by defined benefit pension plans than today's Boomers, and they had greater confidence in Social Security adequacy. Also, for many of them, their conservative instincts, born out of the Depression, had served them well as savers.

Baby Boomers and succeeding generations have another reason to be less certain about retirement readiness than prior generations. Retiree health care costs pose a larger threat today. The blessing of greater longevity comes with a price tag of higher medical costs. Research and technological advances are producing incredible possibilities for extending productive lives. Who isn't for that? But the cost is not only high, but-just as important-it is uncertain. In other words, a financial planner's nightmare.

Benefits planners and other financial counselors are tempted to default to the argument that Medicare will take care of retiree health care costs. But the cost of long-term care alone, which is not covered by Medicare, makes that a specious argument. The challenge of paying for retiree health care calls for a more specific solution than simply encouraging stronger defined contribution plan balances.

Health Savings Accounts (HSAs) provide one way to meet health care expenses head-on-usually during an employee's working years, but potentially also into retirement. HSA balances can be maintained indefinitely; contributions must cease at age 65 for anyone enrolling in Medicare, but they can be continued by others who choose not to enroll in Medicare at 65.

Ryan Tiernan, senior HSA consultant with Access Point HSA, a Rhode Island-based HSA consulting and distribution company, discussed the use of HSAs to pay for retiree health care expenses at a recent Webinar sponsored by the International Foundation of Employee Benefit Plans in partnership with the New England Employee Benefits Council.

Tiernan said that although financial advisors largely see themselves as experts in putting together an asset allocation model and creating an income stream that a client cannot outlive, they have little confidence in their capability to provide advice on retiree health care. "And yet a retirement plan is more likely to be derailed by health problems than any other single cause.

"We see a huge opportunity for the better retirement advisors and consultants to become experts not just in defined contribution and defined benefit plans, but to understand how these plans integrate with HSAs," he said.

The retiree spend-down for health care

Tiernan cited a figure of $225,000 as the average amount a retired couple can expect to spend out-of-pocket on health care expenses during retirement. Why is an HSA a good place to have funds ready for whatever health costs a retiree will face? He pointed out that, like a 401(k), the employee's money is deposited pre-tax and accumulates tax-free. When it is withdrawn to pay for qualified health care costs, the money comes out tax free at any age-an advantage over funds rolled over from a non-Roth 401(k). And individuals can maintain their HSA balances at any age, even including them in their estates.

The person who carries an HSA balance into retirement and decides to use those funds (after age 65) for some purpose other than medical expenses, pays only ordinary income tax on the withdrawals (no further penalty), which is the same treatment they would receive on regular IRA funds.

While still working, an employee could deal with the looming risk of long-term care in retirement by purchasing long-term care insurance and pay the premiums with HSA funds.

Tiernan pointed out that highly compensated employees, while they are still working, may have a particular incentive to accumulate HSA funds for retirement after maxing out their annual defined contribution plan limits. For 2015, an employee under age 50 can put $18,000 into a 401(k) and another $6,650 into their family HSA plan.

The number of HSAs is rising rapidly. Tiernan's presentation cited 2015 figures from Devenir Research showing an annual growth of 29% in HSA participants in 2014 to 13.8 million and 25% in assets to $24 billion. It shows that half of all HSAs were opened in the last three years, Tiernan noted, "which means that these balances are small now, but over time they will grow and become more useful, either for short-term spending or long-term funds for retirement."

Recent figures from the Employee Benefit Research Institute (EBRI) provide a less optimistic view when it comes to employee contributions to their HSAs. EBRI reported that since 2011, individual contributions to Health Savings Accounts have fallen. Individuals who contributed nothing to their accounts rose from 11% to 23%, and those contributing more than $1,500 fell from 44% to 30%. Individual contributions had been growing before 2011. The data came from an EBRI/Greenwald & Associates Consumer Engagement in Health Care Survey.

The cost of retiree health care is the elephant in the room that benefits planners and other financial counselors may be tempted to avoid because it is so large and so uncertain. Will HSAs eventually play a bigger role in confronting this elephant? Time will tell.

What is clear now is that health care costs will present a serious challenge to Baby Boomer retirees, as well as to the generations that follow them into retirement. The time to be dealing with these challenges is while these future retirees are still in the workforce.

The author
Thomas A. McCoy, CLU, retired in 2013 as editor-in-chief of Rough Notes magazine.