While health savings accounts and retirement may not have the same ring to it as peanut butter and jelly or milk and cookies, the unique, tax-advantaged structure of an HSA makes it a valuable complement to retirement planning.
An HSA is a medical savings account available to those enrolled in a high-deductible health plan. Money contributed into the account is used to pay for qualified medical expenses tax-free and any unused funds accumulate each year. Specifically, HSAs can address one of the biggest expenditures facing retirees: rising health care costs.
According to the Employee Benefit Research Institute, a couple retiring in 2016 with median prescription drug costs would need approximately $265,000 saved to cover health care expenses in retirement. While this is no small number, for a millennial who has decades to go before retirement, inflation will dramatically increase this estimate. According to Fidelity Investments’ Retiree Health Care Cost Calculator, a 25-year-old female should be planning to save approximately $665,000 for health care in retirement.
These figures are shocking, and without proper planning, many American workers could be on the precipice of financial catastrophe in retirement. However, as HR and industry professionals, we can equip employees with a tool to help them prepare, and that tool is their HSA. What makes the HSA powerful is that it can offer a three-tier tax advantage: a means to save on a pre-tax basis, achieve tax-deferred growth potential through investment opportunity and withdraw for qualified medical expenses, tax free.
To demonstrate the power of an HSA, let’s look at a hypothetical example: If a family contributed $6,750 annually to the HSA and withdrew $1,100 each year for qualified health costs, they’d have $5,650 accumulating yearly. If they invested the balance and achieved a 5 percent rate of return, they could have as much as $196,164 after 20 years. This money can then be used to fund future qualified medical expenses tax-free in retirement when health care costs will likely be highest for the average consumer.
Given the retirement potential of an HSA, traditional messaging must shift away from how to use the money to ease the burden of high deductibles and today’s medical expenses. However, this comes with challenges. Since HSAs are relatively new, advice on how to effectively use them hasn’t been handed down through generations as it has with traditional retirement vehicles. HR and benefits professionals need to take a paternalistic role in explaining how the benefit works.
Aside from the tax advantages of the HSA, there are a few key details to help employees understand how to strategically use the benefit:
- The money can be invested. As HSA dollars accumulate, investing a portion for growth potential can help employees’ health care savings keep pace with inflation over time. Employees can check with the HSA provider on the various investment options and requirements.
- The timing of reimbursements is flexible. It may be to an employee’s advantage to pay out-of-pocket for health care expenses they can afford now, so that the funds in their HSA can continue to accumulate and grow tax-deferred. However, there’s no time limit on when an employee can reimburse themselves for out-of-pocket qualified expenses. As long as they keep their receipts, qualified expenses can be addressed now or at a later date.
- Viewing the HSA as a retirement vehicle isn’t all or nothing. In the example above, our hypothetical family spent $1,100 per year from their HSA. Positioning the HSA for retirement doesn’t mean that employees can’t touch the money if they need it. Instead, it means employees should be more intentional with how they’re using the account. The tax advantages and growth potential are compelling reasons to allow funds to accumulate each year.
- The HSA provides general retirement income after age 65. In the fortunate event that the HSA balance is higher than what medical costs turn out to be, retirees can use HSA money for nonmedical purposes, taxed as ordinary income, after age 65.
- It’s never too early or too late to benefit. The longer time horizon millennials have to retirement provides them with significant growth potential, and employees over age 55 may be able to contribute a catch-up amount.
As the shifting retirement and health care landscapes continue to put pressure on HR professionals, it becomes increasingly important to use a combined approach to employee education to keep the benefits strategically aligned. This will best support the modern workforce and encourage employees to think of HSAs for what they are, health savings accounts rather than health spending accounts.
Julie LaRocque is a senior account manager and education consultant at Assurance Financial Services. Comment below or email firstname.lastname@example.org.