Retirement plans are about saving for the cost of living in ― retirement. And typically one significant expense for retirees is medical bills. Actuaries at Fidelity Investments estimate that a typical 65-year-old couple retiring in 2018 will incur $280,000 in combined out-of-pocket health expenses during their retirement, excluding the cost of long-term care.
Employers can offer Health Savings Accounts (HSAs) only in combination with their high-deductible health plans (HDHPs). These accounts can be a tax-efficient way to cover medical expenses because they’re designed to be “triple tax-free.” Here’s how that works:
- Tax-deductible employee contributions. Contributions to an HSA (capped at $3,450 for employees with single coverage, and $6,900 for those with family coverage in 2018) are tax-deductible, whether or not employees itemize their deductions. Employee contributions are contributed pretax.
- Tax-free interest and earnings along with any employer contributions. Employees aren’t taxed on any funds contributed to their HSAs by their employer and the growth due to interest and/or investment gains is tax-free. (Employer contributions to HSAs are strictly optional.)
- Tax-free withdrawals for medical expenses. Retirees aren’t taxed on funds withdrawn from their HSAs to pay for eligible medical expenses. From age 65 onward, HSA funds used for nonmedical expenses are taxed as ordinary income, as is the case with non-Roth IRAs and defined contribution plans. Early withdrawals before age 65 for nonmedical expenses are subject to a 20% penalty on top of regular income tax, unlike the 10% premature distribution from a qualified retirement plan.
What’s the trend?
Originally, HSAs were conceived as a tax-friendly way to help employees pay for their deductibles in their HDHPs. Increasingly, however, people are looking at HSAs as a hybrid retirement savings vehicle. According to Devenir Research, 18% of HSA assets today are invested for long-term growth, instead of simply being set aside in cash accounts for short-term use. That’s up from 11% five years ago.
Earlier this year, the U.S. Securities and Exchange Commission issued an “investor bulletin” with tips on using HSAs. Among the tips was a reminder that, like 401(k) accounts, HSAs are portable. So employees can move them to another financial institution if they leave your company. And, unlike Flexible Spending Accounts, balances can be rolled over from year to year without any dollar limitation. Be sure to remind departing participants to research HSA custodians, focusing on investment options and fees.
For a no-obligation discussion on the possible impact and steps you should take now, contact Meresa Morgan, our Audit Shareholder with significant experience in this area.