How HSAs are reshaping retirement
By Charles Paikert
August 28, 2017
Once a retirement planning afterthought, health savings accounts are now a centerpiece of the conversation.
In the past 10 years, HSAs — tax-favored accounts that allow users to save for health care costs their insurance doesn’t cover — have exploded in popularity. Total assets have rocketed to $37 billion in 2016 from $1.7 billion in 2006, according to the consulting firm Devenir Group. By next year, HSA assets are projected to top $53 billion, the firm says.
Public awareness of the accounts got a boost this summer when HSAs were prominently featured in a Republican plan to replace the Affordable Care Act. And the Department of Labor’s fiduciary rule requiring advisors to put their clients’ interests first has also enhanced the growing importance of client-friendly HSAs.
“Advisors can’t ignore HSAs anymore,” says Leo Acheson, a senior analyst at Morningstar. “They’re becoming more prevalent and more effective as a vehicle to save for health costs in retirement, compared with 401(k)s or IRAs.”
Advisors are, in fact, increasingly enthusiastic about HSAs as an integral part of retirement planning. Above all, they praise the triple tax advantage of the accounts: money is deposited tax-free, grows tax-free and can be withdrawn without paying taxes as long as the money is spent on health and medical expenses.“From a tax perspective, it’s incredible,” says Jeff Birnbaum, principal of On Point Financial in New York City. “You just don’t get many opportunities like that in the tax code.”
Nadine Lee, a planner and managing director of metro New York offices for Colony Group, agrees. “HSAs are as tax-efficient as is possible,” Lee says. “The power of compounding interest is magical, and I’m seeing couples amass over $30,000 in savings through HSAs. That really pops.”
Some advisors, like Vicki Fillet Konrad, founder of Blueprint Financial Planning in Hoboken, New Jersey, advocate HSAs as “a really good savings vehicle.”
If her clients can afford to pay their present medical expenses out of their current cash flow, Konrad says, she encourages them to use HSAs for long-term savings. Unlike the case with IRAs, there are no minimum distribution requirements and no requirement to begin withdrawals of HSAs at a certain age.
The maximum allowable contribution to an HSA in 2017 is $6,750 for families and $3,400 for individuals, plus a $1,000 catch-up contribution for employees 55 and older.
Even if clients withdraw money from an HSA after age 65 and use it for nonmedical purposes, they do not incur a penalty, although they do have to pay taxes, Konrad points out.
Unlike IRAs, there are no minimum distribution requirements and no requirement to begin withdrawals of HSAs at a certain age.
Birnbaum, however, cautions that while HSA accounts and their triple tax benefits initially seem like an ideal retirement savings vehicle, advisors need to look at the big picture with individual clients.
For some clients, Birnbaum and other advisors say, paying off outstanding medical expenses with HSAs should take priority over savings. “You need to take care of current obligations first,” Birnbaum says.
He adds that advisors should also investigate clients’ other health insurance options before recommending HSAs, which are available only in conjunction with high-deductible health plans. “If someone ends up paying more for medical expenses compared to what they would have paid with a lower-deductible plan, those additional outlays might leave the person in a worse financial position than if they had the benefit of a plan with a lower deductible,” he explains.
Rather than saving for retirement, in such cases someone would be left with less for retirement.
If an HSA is appropriate for a particular client, he or she must then decide what kind of plan to enroll in and what investments to purchase.
Some 400 to 500 plans are available from providers, according to Morningstar.“Despite the increased interest in HSAs, they remain a very under-researched corner of the marketplace,” says Acheson, one of the report’s authors.
After analyzing 10 of the largest plans — evaluating such criteria as monthly maintenance fees and mutual fund offerings — Morningstar found only one plan “compelling” for use both as a spending vehicle to cover current medical costs and as an investment vehicle to save for future medical expenses. That plan was the HSA Authority, offered through Old National Bank.
“The industry has a lot of room for improvement,” the report concluded.
Advisors should carefully check an HSA’s recurring fees and interest rate for clients with savings needs, Acheson says. For clients able to focus on savings for future withdrawal, advisors should evaluate asset classes offered, allocation options, investment quality and costs, particularly the underlying fund fees.
“Much like the 401(k) market, fees vary wildly from one provider to another,” the Morningstar report says.
Some monthly account maintenance fees were as high as $4.50, the report noted, while some providers waived the fee if accounts had more than a stated minimum and still others, decidedly a minority, did not charge a fee at all.
CAUTIOUS ABOUT RISK
Lee says she advises clients to view HSAs as more conservative investments than traditional retirement plans. “If they need the money for medical expenses, chances are those events will happen earlier,” she says, “so you can’t take as much risk.”
Konrad says she encourages younger clients to be more aggressive in their investment choices, especially millennials with a longer-term investing horizon. “I’ve found that millennials are very savings-minded,” she says. “They see HSAs as a medical 529 plan. I tell them to make the investments automatic and don’t use the plan as a trading vehicle. Set it and forget it.”
Indeed, most clients keep their HSAs assets in cash, according to the Employee Benefit Research Institute, so advisors should remind those with an ability to take on greater risk that a variety of mutual fund options are available in most health savings plans.
Advisors should also remind clients to ask their employers to match their HSA contributions, Lee says. “One of my clients is in his 40s, is very healthy and works in the tech business,” she says. “He doesn’t need much medical attention and wanted to save more money tax-free, so I encouraged him to sign up for a high-deductible insurance policy and open an HSA. Then he talked to his employer, who agreed to match his contribution, so he’s now much better off than he was before.”
Clients should also consider maxing out yearly HSA contributions, says Paul Norr, a financial advisor in Thousand Oaks, California.
A HUGE TAX BREAK
For Norr and his wife, a biotech executive, maxing out HSA contributions with a high-deductible insurance plan made more sense than having a traditional insurance plan and contributing the maximum to a 401(k).
“The tax breaks are huge for people in the upper 10% of incomes,” says Norr, who is also a Financial Planning contributing writer. “At a 38% state and federal marginal rate, a $7,700 HSA contribution saves almost $3,000 in taxes.”
Clients can also use their HSA accounts to pay themselves back for medical expenses they incurred in the past. “There are a lot of wonderful little wrinkles with an HSA,” Konrad says. “It can be like getting an inheritance. You can go back to previous medical bills and reimburse yourself out of the HSA as long as you have proof that you paid the bill.”
But determining eligibility for health savings accounts can be tricky, she cautions, since it’s not always clear whether a particular health plan meets the necessary requirement of being a high-deductible health plan. “All policies need to be checked to make sure they are high-deductible plans,” Konrad stresses.
Clients can also use their HSA accounts to pay themselves back for medical expenses they incurred in the past.
Advisors should also be aware of alternatives to HSAs, Lee says.
Among her clients is a married couple with two children expecting costly medical expenses; the parents expected to incur over $15,000 in unreimbursed bills.
The husband had a full-time job as a CPA and was covered by traditional medical insurance, making the family ineligible for an HSA. But he was also working over 20 hours a week for his wife, who was operating a startup taxed as a sole proprietorship and reported on their joint tax returns.
“I advised the wife to formally hire the husband and work with a benefits consultant to establish a formal Section 105 Medical Expense Reimbursement Plan covering all employees and their families,” Lee says, adding that the husband’s total compensation needed to be reasonable. “With a salary of about $30,000 a year, a benefits consultant determined he could be reimbursed up to $10,000 for family medical expenses.”
The couple’s joint tax return will show the wife’s business declaring $40,000 in deductions and additional W-2 income of $30,000 from the husband. “We anticipate that the family will save about $4,500 by eliminating $10,000 from their gross income,” Lee says.
THE IMPACT OF FEES
For clients who may need all the money they can get for medical expenses and can’t risk losing any principal, Birnbaum says advisors should look carefully at how much fees are eating into health savings accounts. “Putting money in a savings account with no fee outside an HSA may be preferable,” he says. “Fees charged by HSAs can be a big chunk of a small balance.”
One of his clients, a woman in her 50s with heavy medical expenses, had an account balance of $4,260, with account maintenance and expense ratio fees that could exceed 2%. “Based on the fees we saw, it didn’t make sense to put money she needed to pay bills on an ongoing basis into a health savings account,” he says.
The lesson for advisors, Birnbaum says, is to make sure an HSA plan, even if highly rated, is appropriate for each client’s unique situation.