What do you think of when you hear the words “health savings account" or "HSA” as part of an employee benefits package?
If you’re like most people, you mistakenly lump it in with the flexible spending accounts (or FSAs) offered by employers. But while FSAs have annual “use it or lose it” strictures and don’t carry over to the next year, HSAs offer tax benefits and long-term, flexible utility that can pack a powerful one-two punch. This combination can help pay for out-of-pocket health care expenses, and grow an individual’s retirement nest egg.
The Intersection of Health Care and Wealth Care
Challenges: paying for health care, saving more for retirement
Health insurance premiums are expected to continue their steep rise in the coming years. Fidelity estimates that the average couple will need around $280,000 in today’s dollars for medical expenses in retirement, excluding long-term care.1
With the lack of pensions for future retirees and limited tax-deductible savings opportunities in defined contribution plans and IRAs, higher-income singles and couples need to find additional ways to save more money for retirement on a tax-favored basis.
For those enrolled in health coverage at work, HSAs can help address both of these concerns when companies offer them in conjunction with a high-deductible health plan.
Pairing an HSA with a high-deductible health plan
For employees who are generally healthy, lower high-deductible health plan premiums combined with fewer medical claims can reap significant expense savings each year compared to a traditional Preferred Provider Organization (PPO) or Health Maintenance Organization (HMO). These expense savings, in turn, can be redirected into an HSA, which offers several tax advantages:
- Contributions to an HSA are made on a pre-tax basis for up to $3,500 for singles and $7,000 for families (2019).2
- All earnings are tax-free if used for medical expenses.
- HSA values may be withdrawn and used for non-medical expenses. In this case, funds are treated like IRA proceeds with one exception: withdrawn amounts are taxed at ordinary income levels and subject to a 10% penalty tax if withdrawn prior to age 65—not 59½ like an IRA.
If one can avoid dipping into their HSA before they retire, its value can compound over time while they continue to maximize their contributions. That means there should be a larger sum available after retirement, when health care usage—and out-of-pocket expenses—are likely to be more than they are today. And again, these funds can be used for other retirement needs, not just medical costs.
Using supplemental health products to preserve HSA balances
Supplemental products purchased at work can help close the gaps from major medical insurance (specifically high-deductible health plans), minimizing the need to dip into accumulating HSA funds. These group products help provide financial protection for three common drivers of catastrophic medical expenses.
- Critical illness insurance – Pays a lump sum directly to individuals upon diagnosis of a covered condition and these benefits can be used for anything—out-of-pocket medical expenses, lost income replacement and everyday household needs. Most policies cover cancer, heart attacks and strokes, but others also include conditions like multiple sclerosis and Parkinson’s disease.
- Accident insurance – These policies can take many forms, but will pay benefits up to a benefit limit to help individuals deal with the financial burden of a wide variety of accidental injuries.
- Fixed indemnity hospital insurance – Provides a fixed benefit each day an individual is treated at an inpatient hospital, up to a calendar year or other stated maximum. Some carriers also cover admission to an ICU, and inpatient skilled nursing, mental health or substance abuse treatment facilities.
Supplemental health insurance products promote financial wellness by providing assistance during high-cost medical treatments. Individuals focused on saving for retirement and future asset protection can utilize these benefits to allow their HSA to continue on its tax-advantaged growth path, even during times of health challenges.
Using a health savings account to enhance supplemental retirement savings
For those who have the patience to allow the magic of compounding to do its work, it can make sense to maximize HSA contributions each year and avoid HSA withdrawals while finding other ways to offset high deductibles for current health care expenses.
If deferred until retirement at age 65+, accumulated values have a chance to grow to a higher sum. HSA funds can then be used to supplement Medicare premiums or other eligible related medical costs on a tax-free basis during the retirement years. As a result, other assets like defined contribution plans, IRAs or brokerage accounts may be left to grow further tax-free until later withdrawal. And as a reminder, HSA assets can always be used for non-medical expenses; however, they are subject to income tax, and an additional 10% tax penalty if used before age 65.
Health savings accounts: take a closer look
HSAs can be powerful, creative tools if used properly. But with too many plan participants today still confused about the true potential of HSAs, they are being used to cover annual copays and deductibles rather than being allowed to compound over time. Their unique tax advantages at the contribution and withdrawal phases, combined with their portability and generous contribution limits, make HSAs worth a closer look.
1 How to Plan for Rising Health Care Costs. Fidelity Viewpoints, April 18, 2018, https://www.fidelity.com/viewpoints/personal-finance/plan-for-rising-health-care-costs
2 IRS Revenue Procedure 2018-30, https://www.irs.gov/pub/irs-drop/rp-18-30.pdf