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Retirement Perspectives

In the first part of a three-part series, we explain how advisors can help clients learn how to use them.

Health Savings Accounts (HSAs) are growing in popularity and quickly have become a significant benefit for workers, as well as a core component of their retirement savings strategy.

HSAs and retirement accounts are related by more than the fact they are employer provided benefits. As health care costs continue to increase, individuals’ retirement savings may be affected. The more money an individual has to spend on health care expenses, the less money he/she will have available for other retirement related costs—for both necessities and leisure activities.

Considering rising health care costs and insurance premiums, plus extended life expectancies, it’s easy to see why more workers are establishing HSAs as more employers offer them. According to Fidelity’s Heath Care Cost Estimate, a 65-year-old couple who retired in 2018 will need $280,000 to cover health care costs in their golden years—a 75% jump from the firm’s first projection of $160,000 in 2002. This underscores the need for advisors to discuss the flexibility and power of HSAs with clients.

 

Source: Fidelity Investments. These are the estimates for the last 16 years that Fidelity has been calculating this dollar amount. As of 12/31/2018.

 

HSAs were created as part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. HSAs are triple tax-advantaged, which means that contributions are tax deductible, distributions (of contributions) are tax free, and earnings are distributed tax free as long as the proceeds are used to cover qualified medical expenses. HSAs paired with High Deductible Health Plans (HDHP) also enable employers to lower premiums by creating higher deductibles and increase “cost sharing” with employees.

HSAs are Triple Tax Free
The main benefit of an HSA is it is triple tax free. In fact, an HSA is the most tax-advantaged savings account available. Even Roth, with its slew of benefits, doesn’t offer a tax-deductible contribution. Instead, Roth accounts are funded with aftertax dollars.

Tip: Contributing to an HSA through payroll is not subject to payroll taxes thus, saving an individual 7.65% (the employee’s half of the 15.3% payroll tax). 

 

HSAs offer:

1. Tax deductible contributions,

2. Tax deferred growth and

3. Tax free distributions for qualified medical expenses

 

HSAs are distinctive compared with their tax-advantaged account counterparts (e.g., IRAs, qualified plans, etc.). As Nevin Adams, chief of marketing and communications for the American Retirement Association put it:  “HSAs provide their account owners a triple tax advantage: contributions to an HSA reduce taxable income, earnings on the assets in the HSA that build up tax free, and distributions from the HSA for qualified expenses that are not subject to taxation.” Due to this unique tax structure, a larger number of investors have been using HSAs as a way to save for future medical expenses.

As a result, HSAs are growing in number and importance. Since the inception of HSAs, enrollment in HSA-eligible health plans has increased to 23.4 million, up 11% from a year ago, while assets rose to $51.4 billion, a 20% rise from a year ago for the period ended June 30, 2018, according to Devenir Research. The research firm projects $75 billion in HSA assets by the end of 2020, held in more than 29 million accounts.

 

Source: Estimates derived from 2018 Midyear Devenir HSA Market Survey, press releases, previous market research, and market growth rates. As of June, 2018.

 

How does an HSA work?
With smart planning, a younger individual can fund his/her HSA today, and potentially let the account accumulate assets without distributing any proceeds until later in life, potentially as late as retirement. Distributions from an HSA can be made at any time (unlike flexible spending accounts, which follow rigid “use it or lose it” distribution rules).

An HSA offers a way to pay an individual back for a previous medical expense tax-free. For example, John, 29, has an HSA valued at $10,000. He goes to the local walk-in medical clinic due to a nasty cough. The visit costs John $90 plus $30 for medicine. John can reimburse himself in the amount of $120 at any time in the future (even decades later) by taking a tax-free HSA distribution.

The key to maximizing HSA benefits is to pay most, if not all, medical expenses out of pocket, while also contributing to the HSA to cover future medical expenses. Because the reality is that it’s impossible to leverage the tax-free benefits of an HSA until and unless it has been given time to grow,. Thus, an HSA can be treated as a supplemental retirement savings plan, specifically earmarked to provide (tax free distributions) for qualified medical expenses in retirement where it can fund everything from actual medical expenses, including most long-term care, prescription drugs, co-pays and deductibles of HDHPs. Of course, clients (and their spouses and dependents) have medical costs throughout their lives. So, if at all possible, I believe it’s advisable to encourage them to tap other funds, while their HSA accumulates.

 

Chart is for illustrative purposes.

 

More Education Is Needed
More than 40% of investors don’t have any familiarity with HSAs and their triple tax advantage, according to the Willis Tower Watson 2018 Health Accounts Employee Attitudes Survey. Only 30% of investors enrolled in a HSA make regular contributions. Of those, 65% say they use their HSA money for current health needs, while only 8% save for the future, according to the Willis Tower Watson survey. Workers are immediately tapping their HSA to pay for current medical bills, as opposed to using other sources (e.g. checking or savings account) of savings to allow the HSA to accumulate tax deferred.  What’s more, given that many investors don’t always seek professional advice, many aren’t aware of – nor do they know how to evaluate available HSA investment options (e.g mutual funds). According to Devenir Research only 19% of all HSA assets are in investments as of June 30, 2018. I believe there is a correlation between this savings gap and (lack of) education. Financial professionals have a tremendous opportunity to help investors learn and take advantage of the myriad of benefits of both tax-advantaged retirement and HSAs.

 

Source: Estimates derived from 2018 Midyear Devenir HSA Market Survey, press releases, previous market research, and market growth rates. As of June, 2018.

 

Part 2 discusses HSA eligibility, contributions limits, and distribution strategies.

Part 3 covers rollovers, beneficiaries, and other rules.

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

About The Author

WEBINAR
 

videoJoin our conference call with Brian Dobbis in a discussion about Roth accounts, IRA strategies, and other retirement trends on Wed., Mar. 27 at 4:15 pm ET.

*Financial professionals only.
Earn CE credits (1 CFP credit).

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