Benefits Products & Services
By Thomas A. McCoy, CLU
THE HSA’S FUTURE AS A RETIREMENT PRODUCT
Looming healthcare expenses, tax benefits make it enticing
Nothing in this world is certain except death and taxes. So said Ben Franklin back in 1789. We would add healthcare expenses to the list of life’s certainties. How today’s employee benefit plan participants address their inevitable healthcare expenses, now and in the future, will have a defining effect on their financial security.
One tool that can be used by benefit plan participants to address two of the inevitables—taxes and healthcare expenses—is a health savings account (HSA). Since HSAs were introduced in 2004, workers have used them primarily as a deposit-withdrawal mechanism during working years to pay for current healthcare expenses not covered by a primary insurance plan.
These could be common expenses falling below the medical plan deductible. Or they could be unanticipated large ones. Think braces for kids.
Figures compiled by the Employee Benefits Research Institute (EBRI) over the last 10 years show that HSA account holders are utilizing their account balances extensively during their working years. In 2019, 60% of account holders withdrew funds from their HSAs, taking out an average of $1,897.
A recent webinar hosted by the EBRI focused on broader use of an HSA—how it can be integrated into retirement planning. Jake Spiegel, research associate at EBRI, pointed to the advantages of workers holding onto HSA balances and using them for uninsured healthcare expenses in retirement.
“It’s all about the taxes. Only the HSA provides the preferential tax treatment on contributions, investment growth and withdrawals.”
JP Morgan Asset Management
He said that while retiree healthcare costs vary widely, EBRI estimates that a married couple with high prescription drug costs could need $325,000 to cover their healthcare expenses in retirement. Whatever the figure turns out to be, it is substantial and unpredictable.
HSA funds accumulated during working years could provide a reassuring cushion for retirees. Spiegel noted that an employee contributing the current individual maximum of $3,600 to their HSA for 20 years and taking no distributions would have accumulated $118,000 to be used in retirement, assuming a 2.5% return; at a 7.5% return, the sum would be $193,000.
Individuals accumulating funds this way and using them for healthcare in retirement receive a triple tax advantage. Contributions, growth and distributions are all tax free, just as they are before retirement.
Beyond the $3,600 individual contribution limit ($7,200 for families), there is a $1,000 catch-up contribution allowed for those over age 55 (just as there is for 401(k)s and IRAs). Any amounts the employer contributes to the HSA is excluded from the employee’s taxable income.
Sharon Carson, executive director of JP Morgan Asset Management, said, “It makes sense for plan participants with HSAs who can afford to pay for their current healthcare expenses separately to let their HSA balances build up as part of their retirement savings.”
In fact, she told the EBRI webinar audience, if the benefit plan includes employer contributions to an HSA, she considers it a higher savings priority than every other saving option except for a three- to six-month emergency fund.
Her recommended hierarchy of savings choices within a benefit plan from highest to lowest is: the emergency reserve (for living expenses); an HSA, if eligible for a match; the DC plan up to the employer match; maximizing additional HSA contributions; and maximizing additional DC plan contributions.
In comparing HSAs to 401(k)s and IRAs—both traditional and Roth—she stressed, “It’s all about the taxes. Only the HSA provides the preferential tax treatment on contributions, investment growth and withdrawals. With 401(k)s, you’re either taxed on the way in or the way out.”
In retirement, she notes, the tax-free treatment of HSA withdrawals “could be used to pay qualified medical expenses, prescription costs, long-term care premiums up to certain limits, and some health-related modifications of your home.”
She pointed out also that if any of the HSA funds have to be used for non-medical purposes after age 65, there is no penalty, but the individual would be taxed at ordinary rates.
By including an HSA as part of the retirement product mix, an employee is focusing on both the income and outflow of funds. Thus, they see a more complete picture of what their financial situation will look like in retirement. Tackling medical costs is a sensible place to start.
“We know that plan participants worry about the healthcare expenses they will face in retirement,” Carson said, “but as they get close to their retirement date, they need to know, ‘how much is this going to cost me per month and per year, and how does that compare to what I am paying out of pocket now?’”
She presented a model of healthcare expenses for someone retiring at age 65, and then projected the cost increases that an individual might expect over the next 30 years, averaged at 5.6% annually. It included a Medigap Plan G; other out-of-pocket costs such as vision, dental and hearing; Medicare Part A and B deductibles; median prescription out-of-pocket costs and Part D premiums; and Medicare Part B premiums.
These expenses totaled $479 per month in 2021, and were projected to grow to $1,353 by 2051. The model adds in another $164 per month for uncertainties such as inflation variability and Medicare solvency issues, bringing the total to $1,517 per month by the end of the 30-year-period.
“So, in today’s dollars, those costs are going to more than triple over 30 years,” Carson said. “Some higher income retirees may be subject to Medicare surcharges at some point,” she noted. So for them, “6% may be a more appropriate assumed rate of inflation than 5.6%.”
Carson went on to explain a different healthcare cost model for retirees using Medicare Advantage Plans. For these plans, she pointed out, the premiums are lower, but the variability of potential out-of-pocket costs are greater, so retirees using them will need to budget for this greater uncertainty.
For all the practical advantages of using HSA funds as a retirement savings vehicle, the concept appears to be mostly futuristic for now. Although average HSA balances tracked in the EBRI database rose from $2,187 to $2,692 in 2019, 63% of accounts had a distribution. Nearly 40% of account holders withdrew more from their accounts than they contributed, and very few contributed the statutory maximum.
A recent EBRI publication notes that in 2019, “Most (55%) HSA accounts that did not record a distribution also did not receive either an employee or an employer contribution. This suggests that the lack of distributions was not because account holders are increasingly using HSAs as savings vehicles, but rather because the account holder has become disengaged from the account.”
Todd Berkley, vice president of Conduent HR, said one of the biggest barriers preventing employees from accumulating HSA funds for retirement is simply that they forget they can carry over their balances each year with no time limit. “Before they come to an HSA, employees often have a Flexible Spending Account (FSA) with a ‘use it or lose it rule,” so they tend to stay in that mindset when they come to an HSA, and only put in the amount they think they will need each year.”
The HSA already serves a useful purpose for employees using it to pay for healthcare expenses during their working years. Its use as a retirement planning tool remains largely unfulfilled for now. But retirement products and strategies are far from static. Just as Roth 401(k) accounts became a highly favored addition to traditional 401(k) plans, HSAs may yet wind up as a mainstream retirement planning product.
Thomas A. McCoy, CLU, is an Indiana-based freelance insurance writer.