Building a Second Nest Egg | The truth about Health Savings Accounts

August 08, 2019
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A lot of your employees probably don’t understand how much a health savings account (HSA) can help them get set for their medical expenses in retirement.

Health-care expenses make up a big part of a retiree’s budget. Fidelity Benefits Consulting estimates that the average couple retiring in 2019 will need $285,000 in today’s dollars for medical expenses in retirement, not counting long-term care. I think that number may even be conservative.

But when I talk to our clients’ employees, it’s clear that many people haven’t really thought about their medical expenses in retirement. Mostly, they just (mistakenly) assume that they’ll get blanket Medicare coverage.

I think people should take full advantage of every available tool to save for their retirement health-care expenses. Your employees face annual 401(k) contribution limits, of course: $19,000 for individuals and another $6,000 for participants 50 and older. But they can sock away more money if they’re in a high-deductible health plan and have an HSA account: up to $3,500 annually for individuals and $7,000 for families. So they can build up a second nest egg, money to dedicate to their health-care expenses in retirement.

At Atlanta Retirement Partners, we’re talking more with clients and their employees about saving for medical expenses in retirement. We cover it in our financial wellness program, and we’ve put together a group education session focused on helping employees see HSAs as a valuable way to do that.

Three Common Myths
Broadening employees’ minds about how they can utilize HSAs means debunking some common myths:

Myth: You must spend HSA money by the end of each year. We’ve all gotten into such an FSA mentality. With an FSA (flexible spending account), the account holder has to spend every dollar in his or her account before year’s end, or lose that money. But that’s not how HSAs work. An HSA balance can accrue indefinitely, and an account holder can use the money anytime, including long after he or she stopped contributing to the account.

Myth: You can’t invest your HSA account balance. People think the money just sits there, not doing anything. Some HSAs do have a required cash threshold (keeping at least $1,000 in cash in the account, for example), but an account holder can invest the balance beyond that. People can accrue earnings on the investments, increasing their second nest egg. Most employers I’ve seen that offer an HSA have one with a core investment menu, but others opt for an HSA with a brokerage window. Both approaches enable account holders to diversify their investments.

Myth: You can’t pay Medicare premiums with HSA money. Before age 65, the IRS does not allow people to use HSA money to pay their insurance premiums, except under limited circumstances. So people often assume that’s also true about paying Medicare premiums. But you can use HSA money to pay premiums for Medicare Part B, Part C (Medicare Advantage Plans), and Part D. Fidelity estimates that Part B and Part D premiums make up 39% of a retiree’s health-care expenses, so that’s a significant budget item people can pay tax-free with HSA money.

The Triple-Tax-Free Advantage
Here’s the fun part of doing HSA education: explaining HSAs’ unique, triple-tax-free advantage. People get a tax deduction when they contribute to their HSA, and their account’s investments accrue earnings on a tax-free basis. Then, as long as people withdraw the money to pay for qualified medical expenses (as spelled out in IRS Publication 502), they don’t get taxed on the withdrawal. So people have just experienced an entirely tax-free ride, never paying a dollar of taxes on that money.

That’s an especially valuable benefit for younger folks in the workforce. Many are in pretty good health and have low medical expenses, so a high-deductible insurance plan may work well for them. If they also start saving in an HSA, their investments’ value can grow in that account for decades. Even if they later decide to switch out of a high-deductible plan (and no longer can contribute to an HSA), the money they’ve already saved can still grow tax-free—which means that their second nest egg keeps getting larger.

Once they see how an HSA can help them save for their retirement expenses, people may wonder how to prioritize 401(k) saving versus HSA saving. Here’s what I suggest: First, people should prioritize contributing enough every year to their 401(k) to get the full employer match. Once they’ve done that, they should max out their HSA contribution next. And then, since lots of studies say that people need total (employer plus employee) contributions of at least 15% annually for retirement, they ought to think about contributing even more to their 401(k).

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This information was developed as a general guide to educate plan sponsors but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.