HSAs, an Attractive Complement to Traditional Retirement Plans

Business owners and highly-compensated executives often want to know how they can get more money into their company-sponsored retirement plan. It is common for plans to be designed to assist the high earners of companies with achieving their ultimate goal of ensuring they have a large nest egg of qualified tax dollars at their retirement. However, we frequently observe situations where high earners fail to also maximize the benefits of their own personal Health Savings Accounts (HSAs). Many don’t realize that HSAs can be a valuable and flexible supplement to standard retirement savings.

While 401(k)s are often considered the pinnacle of retirement accounts, HSAs can also be a beneficial savings option. HSAs work in conjunction with a High-Deductible Health Plan (HDHP) to allow employees to cover qualified medical expenses. While individual tax situations vary, the HSAs generally provide a triple tax benefit as contributions are pre-tax, grow free of income and capital gains taxes, and are tax-free when withdrawn for qualified medical expenses. Additionally, unlike health Flexible Spending Accounts (FSAs), HSAs are not subject to the “use it or lose it” rule. Funds remain in your account from year to year, and any unused funds may be used to pay for future qualified medical expenses, allowing you the ability to build a large tax-free savings account over the years. So, if you have the cash available to pay your medical costs out of pocket, you can let your entire HSA grow tax-free for future qualified medical, dental and vision expenses.

HSAs offer additional flexibility compared to an IRA, 401(k) or FSA. Unlike an IRA or 401(k), you can access the funds in your HSA at any time and there are no forced distributions based on age. HSAs take on some characteristics of an IRA, since the funds can be pulled out at any time (like an IRA) but if used for broadly defined medical expenses, the distributions are tax-free, like a Roth IRA. On the downside, the annual contributions to HSAs are far less than 401(k) plans and many defined contribution plan options. For comparison, the 2021 IRS contribution limits for HSAs are $3,600 for individual coverage and $7,200 for family coverage, with an additional $1,000 per year catch-up contribution available for those age 55 or older (limit of 1 individual’s catch-up per account). Said another way, families can contribute over $9,000 per year between 2 tax-advantaged HSAs. The 2021 IRS individual employee deferral limits for 401(k)s, 403(b)s, and 457(b)s are a combined $19,500, with an additional $6,500 per year catch-up contribution for those age 50 or older.

It is common to see Roth 401(k) and Roth IRA dollars being used as a strategy to provide income tax diversification in later years. Essentially, having Roth dollars available in retirement allows an individual to control their effective tax bracket by coordinating the amount of dollars drawn from both the pre-tax and Roth buckets each year. A well-funded HSA can quickly become a third bucket in an income tax diversification strategy because the money used to pay qualified medical expenses is not subject to Federal income taxes. According to Fidelity Investments, in retirement, the average couple spends over $220,000 on health-related expenses. It is worth noting that even the payment of insurance premiums is considered a qualified medical expense. Additionally, after the HSA owner reaches age 65, the HSA operates like an IRA and funds can be withdrawn penalty free for payment of non-healthcare related expenses. However, any non-healthcare related expenses are subject to income tax requirements, regardless of the owner’s age, similar to an IRA.

As long as your qualified healthcare expenses occurred after your HSA was established, your withdrawal will be tax-free if the funds pay for a current health related expense or reimburse a prior year’s expense (even from many years earlier). This allowance from the IRS has created a unique emergency savings feature through health savings accounts. Qualified reimbursement can be pursued many years after the expense occurred. When a non-medical emergency arises and you need access to funds, you can seek reimbursement for past healthcare expenses sufficient to cover the current emergency. An HSA allows access to pre-tax funds equal to qualified healthcare expenses that you’ve already paid. In other words, savings to an HSA can be invested, grown tax-free for decades, and finally distributed after many years of compounded, tax-free growth to pay for current expenses. However, it is crucial to have proper documentation to justify the reimbursement.

HSAs are employee-owned, portable investment or banking accounts that remain with you through job transitions. While not widely advertised, many employers will direct your HSA payroll deductions to the custodian of your choice. In recent years, Greenleaf Trust has seen a growth in the number of HSAs we manage, as clients have begun to embrace the strategy of capturing the tax-free investment earnings and accumulating the dollars for use in future years. Additionally, there has been a growth in the number of third-party vendors offering inexpensive administration services, coupled with brokerage accounts that allow individuals the option to select their own investment allocation based upon their long-term savings goals. Empowering employees to save money for future healthcare needs is one way that employers can leverage benefits to help employees plan ahead. Employers can help employees understand the value of a HSA by comparing it to a 401(k), but for healthcare.

As mentioned, HSAs are a regularly overlooked retirement savings vehicle; if you have the cash available to pay your medical costs out of pocket, you can let your entire HSA accumulate tax-free for use on future qualified medical, dental and vision expenses. Dollar-for-dollar HSAs provide the most IRS bang for the buck due to the triple tax benefit as contributions are pre-tax, grow free of income and capital gains taxes, and are tax-free when withdrawn for qualified medical expenses. Greenleaf Trust is here to help by providing administration services for company-sponsored retirement plans and investment savings options for those individuals who wish to accumulate their HSA dollars for use in retirement. Feel free to reach out to any member of our Greenleaf Trust team if you would like to learn more about our specialized services.