How Using Health Savings Accounts with 401(k) Benefits Can Help Your Employees

With healthcare costs continuing to climb, and as more Baby Boomers get ready to retire, your employees may be asking: Is there anything you can do to prepare for the potential costs of taking care of yourself while you age? It’s a question a majority of Americans have considered, as research finds that most people are concerned about unexpected healthcare costs in their future.

There’s an incentive-laden solution that is sometimes overlooked—and long underutilized by many business owners and employees—but has been gaining traction in recent years: Health savings accounts (HSAs). About 30% of employers currently offer them, but that number is expected to keep rising.¹

Health savings accounts shouldn’t be confused with flexible spending accounts (FSAs), because FSAs are “use it or lose it,” meaning the money disappears if it isn’t used on a qualifying cost within a year. With an HSA, you keep your money, gain tax advantages, and can invest your HSA funds to grow them over time, like a 401(k). Unlike a 401(k), funds can be used at any time to pay for healthcare expenses, rather than being forced to wait until retirement age or pay penalties. For these reasons, the number of enrollees in HSAs has grown from only about 1 million people in 2005 to an estimated 23 million to 36.8 million in 2018.²

The Increasing Cost of Healthcare

According to a report from the Employee Benefit Research Institute, couples in their mid-60s can expect to devote $165,000 to $349,000 to their healthcare costs in retirement, depending on prescription drug and long-term care costs.³ When planning for retirement, medical costs are sometimes an afterthought, or the belief is that Medicare will cover out-of-pocket expenses. In reality, Medicare covers only about 62% of healthcare costs.⁴ That gap means a lot of money that was allocated for living expenses could be going toward unexpected medical needs.

Of course, everyone’s needs are different, and the best way to see where you might fall in this spectrum is to get an estimate. The AARP healthcare costs calculator might be a good place to start.

Health Savings Account Tax Benefits

HSAs are sometimes referred to as having a “triple tax advantage,” because they offer the following perks:

• Contributions are made with pre-tax dollars

• Invested income grows tax-free

• Funds used to pay qualified medical expenses aren’t taxed

IRS Publication 969 lists qualified medical expenses for HSAs, and includes just about every healthcare-related expense a retiree could face, including dental and vision expenses, prescription drug costs, and other non-physician healthcare.

What are the Limitations of an HSA?

• The primary limitation is that only those with high-deductible health plans are eligible to use HSAs. What’s considered “high-deductible”? For 2020, the rates are $1,400 for individuals and $2,800 for families.

• Contribution limits for 2020 are $3,550 per year for an individual, and $7,100 for a family. Some employers opt to match funds, much like 401(k) matching contributions, but employees can fully fund their own accounts with after-tax dollars.

• Like 401(k) contributions, catch up provisions allow people age 55 and older to contribute an additional $1,000 per year.

• Once you sign up for Medicare (for those 65 and older), you can no longer contribute funds to your HSA account.

• If you decide to withdraw funds for non-qualified expenses, those distributions become taxable as income, plus a 20% penalty.

It’s important to note that once you turn 65, non-qualified distributions are penalty-free, like 401(k) withdrawals, and can act as additional retirement income should you decide to pull from your account.

Using Your HSA and Company-Sponsored 401(k) Plans as Complementary Benefits

Because HSAs are still relatively new, having been around for only about a dozen years, many Baby Boomers and employees in their 60s either haven’t utilized or don’t have a large balance in their accounts. However, it’s likely that your employees will still encounter difficult or costly medical situations during retirement that may affect their 401(k) account balances, or require expensive professional long-term care.

If you already offer HSAs or are considering them at your business, consider engaging pre-retirement employees to contribute now so that their balances in retirement can grow to potentially handle high healthcare costs—and prevent tough financial situations when it’s not feasible for them to work any longer. Paired with a 401(k), an HSA can help create an ideal financial situation for the employees you care about once they reach retirement.

¹ https://www.bostonglobe.com/business/2017/01/06/this-could-breakout-year-for-health-savings-accounts/Kx3mwiaGzgQF5HbQDiKfVM/story.html
² https://www.ebri.org/docs/default-source/ebri-issue-brief/ebri_ib_478_hsaenrollment-28mar19.pdf?sfvrsn=e86b3f2f_4
³ https://www.ebri.org/publications/notes/index.cfm?fa=notesDisp&content_id=5527
⁴ http://www.marketwatch.com/story/you-might-need-nearly-350000-to-pay-for-health-care-costs-in-retirement-2017-02-02