Andrew Crowell, Vice Chairman of Wealth Management
Is it possible to save for both medical bills and retirement? According to a 2018 Employee Benefit Research Institute report,1 a 65-year-old couple, both with median prescription drug expenses, may need an estimated $296,000 in savings to have a 90% chance of having sufficient funds for healthcare expenses in retirement. Since healthcare expenses have historically risen faster than the cost of living, having a plan to cover these future expenses is critical.
One tool that can help: the Health Savings Account (HSA), which can be used to save for both medical costs and retirement if you are covered by a high-deductible health plan. In addition to offering tax-advantaged reimbursements for qualified healthcare expenses, HSAs carry other benefits that can assist with stretching savings and thereby potentially improve an investor’s financial health. HSAs can be particularly attractive if your employer offers an incentive for you to participate.
Contributions to HSA plans are made with pre-tax dollars, providing a current tax-year benefit by lowering an investor’s adjusted gross income, according to the IRS.2 Contributions inside the HSA grow tax-free and distributions for qualified expenses are also tax-free. HSA plans are portable should the owner change employers. Most HSA plans offer a variety of investment options, which means contributions can potentially grow even faster than if they were in a simple interest-bearing account.
HSAs vs. 401(k)s
For employees who participate in 401(k) retirement plans through their companies, it is prudent to compare the differences between these plans and HSAs. Traditional 401(k) plans are designed for retirement savings and have higher annual contribution limits, so retirement savings can build up faster with a 401(k). Many employers “match” 401(k) contributions, allowing employees to essentially earn free money for retirement savings. However, traditional 401(k)s have required minimum distributions (RMDs) that force savers to begin taking out funds at age 70½, whether needed or not.
By contrast, HSA plans have lower annual contribution limits and typically do not include employer contributions. Because unused balances can roll over to subsequent years, it is possible for an HSA balance to build up meaningfully over time (if an investor’s budget permits paying some healthcare expenses out of annual cash flow, or healthcare expenses are lower than the contributed funds). Further, because HSAs do not have RMDs, they can grow indefinitely during the owner’s life. Finally, unlike 401(k) contributions, HSA contributions are not subject to Social Security and Medicare tax, thereby receiving another 7.65% benefit.
It is important to be aware of the limitations of these plans as well. One of the largest potential disadvantages is the stiff 20% penalty on top of ordinary income tax treatment for non-qualified medical expense distributions if the investor is under age 65. That means it is important to keep thorough records and only use distributions for qualified medical expenses. Also, some states — like California — prohibit a state income tax deduction for HSA contributions. HSA contributors should consult with a tax expert to understand the advantages and limitations in their situation.
When researching HSA providers, investors should carefully read the fine print. There may be inactivity fees or maintenance fees that can rapidly erode savings. There also may be fees imposed should the investor no longer qualify to contribute. For example, if a current employer has a high-deductible health plan but the next employer does not, the investor would no longer qualify to contribute to the HSA while covered under the new employer’s health plan. They will then need to make sure that inactivity fees and/or annual maintenance fees do not chip away at the benefits they have worked to accumulate.
Just as implementing healthy diet and exercise habits during working and retirement years can increase vitality and longevity, so too can healthy financial habits like regular saving, prudent investment and disciplined spending. If used correctly, accounts like HSAs can be helpful tools for stretching retirement dollars and covering future qualified medical expenses.
1 Employee Benefit Research Institute
2 IRS: Health Savings Accounts
The information in this article is not investment or securities advice and does not constitute an offer. Neither the information nor any opinion in the article constitutes a solicitation or offer by D.A. Davidson or its affiliates to buy or sell any securities, options, or other financial instruments or provide any investment advice or service. D.A. Davidson Financial Advisors are available to discuss the ideas, strategies, products, and services described herein, as well as the suitability and risks associated with them. D.A. Davidson does not provide tax or legal advice. Questions about the legal or tax implications of any of the products or concepts described should be directed to your accountant and/or attorney.