Today's Retirement

Health Savings Accounts: The New Retirement Planning Tool

Making the most of the tax-saving benefits that health savings accounts offer… both today and in retirement

by George W. Schein, JD

Mr. Schein is director, Advanced Consulting Group, Nationwide. Visit www.nationwide.com

Health savings accounts (HSAs) are a great option for clients seeking tax-advantaged savings vehicles. However, many clients do not understand how to take full advantage of their HSAs, or even the benefits HSAs offer. In fact, 65 percent of those who contribute to an HSA are not using it as an investment vehicle.1 And only one in five (20 percent) U.S. business owners fully understand important elements of HSAs.This presents an opportunity for advisors to educate clients planning for retirement on how they can maximize the benefits of their HSAs by taking advantage of the special HSA rules. And clients are hungry to learn more – three in four U.S. business owners expressed interest in talking to a financial advisor about employee benefits that reduce company taxes (77 percent), offer employee tax savings (74 percent), or increase retirement savings (76 percent).2

The following Q&A will help advisors to better understand HSAs and may be used as a reference in educational conversations with clients. It helps to explain how an HSA may be utilized as an additional savings vehicle that can supplement retirement savings plans, ease retirement concerns around healthcare costs and offer tax benefits not found in other retirement accounts.

What are qualifying medical expenses that can be reimbursed on a tax-free basis using an HSA?

The IRS defines qualified medical expenses to generally include the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body.3 Transportation costs primarily for, and essential to, medical care may also qualify as medical expenses, as do amounts paid for qualified long-term care services, and limited amounts paid for long-term care insurance contract premiums.4 This description is quite broad and includes many medical, prescription drug, dental, and vision related expenses. However, note that one limitation to qualified medical expenses is that they must be primarily to alleviate or prevent a physical or mental disability or illness. Expenses that benefit general health and wellbeing, such as dietary supplements or membership at a local gym, are not generally considered qualified medical expenses.5

Why are HSAs important for financial advisors to understand?

First off, HSAs are an additional tool to help your clients reduce their income tax burden. Secondly, healthcare costs are rising faster than both wages and inflation, which has been the case for quite a few years. This negatively impacts long-term savings for retirement. Furthermore, rising healthcare costs mean a larger proportion of an individual’s retirement savings will ultimately be spent on future medical expenses. In fact, one recent study found that a couple retiring today may very well need up to $400,000 to pay for healthcare costs throughout the remainder of their retirement.6 You need to be able to help your clients plan for and address this reality.

How do HSAs help employers and employees reduce taxes?

rising healthcare costs mean a larger proportion of an individual’s retirement savings will ultimately be spent on future medical expenses. In fact, one recent study found that a couple retiring today may very well need up to $400,000 to pay for healthcare costs throughout the remainder of their retirement...

Employee contributions made to their individual HSAs that are facilitated by their employer via payroll deductions through a Code Section 125 cafeteria plan are not subject to federal (or state, if applicable) income tax or FICA tax. Employers also realize tax savings here, because they also do not have to pay their share of FICA tax on those pre-tax employee contributions. In addition, an employer can deduct as a business expense their own employer contribution to their employees’ individual HSAs, which further reduces the employer’s own income subject to taxation.

How do HSAs help individuals save for retirement?

HSAs are an effective tool to help save for medical expenses in retirement because of the unique “triple-tax free” status granted them by the Internal Revenue Code. Contributions (up to the legal limit, which is adjusted annually) (1) go into an HSA on a tax-free basis, (2) where they can be invested and grow over the years tax-free, and (3) the eventual distributions to pay for qualified medical expenses will be tax free.

Another option for an HSA-eligible individual, particularly one who is healthy and has more discretionary income, is to pay for current medical expenses out-of-pocket and save current income into his or her HSA on a tax-free basis. He or she can then invest that money and let it grow within the HSA on a tax-free basis, and then (1) use future distributions from that HSA to reimburse him/herself on a tax-free basis for past qualified medical expenses paid out-of-pocket (assuming the participant has kept receipts and can substantiate those out-of-pocket payments), or (2) pay for future qualified medical expenses during retirement.

Finally, it is important to note that once individuals reach age 65, they are also permitted to take distributions from their HSA for non-medical expenses without any tax penalty. Such a distribution would be subject to regular income tax rates similar to a distribution from a traditional 401(k) plan or traditional IRA. ◊

 

 

Endnotes
1. 2018 Nationwide Health Care and Long-Term Care Consumer Survey conducted by The Harris Poll on behalf of the Nationwide Retirement Institute (2018). The fourth annual survey was conducted online within the United States from Feb. 5-22, 2018, among 1,007 adults ages 50 and older who have a household income of $150,000 or more (“affluent adults”), and 522 adults ages 50 and older who are or have been caregivers.
2. 2019 Nationwide Business Owner HSA Survey conducted by Edelman Intelligence on behalf of the Nationwide Retirement Institute (2019). The survey was conducted online within the United States from Feb. 14-22, 2019, among 406 U.S. business owners ages 18 and older with 11-500 employees.
3. I.R.C. 213(d)(1)
4. Id.
5. IRS Publication 502 (2018)
6. “Savings Medicare Beneficiaries Need for Health Expenses: Some Couples Could Need as Much as $400,000. Up from $370,000 in 2017” – EBRI, October 8, 2018 0