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Many Americans invest and prepare for retirement the same way they did decades ago, but what worked 40 years ago might not be the best approach today. Fortunately, there’s an often overlooked way to help employees build wealth and prepare for retirement. And it’s a solution you might already be offering: the health savings account (HSA).

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What EMPLOYEES are saying about their finances and retirement

A variety of recent studies have indicated that:

  • Nearly twice as many employees said they were stressed about their finances than said they were stressed about their jobs.
  • 47 percent of all employees say financial stress has caused them to either miss work or has negatively affected their productivity.
  • 54 percent of all employees say financial challenges are their biggest cause of stress.
  • 45 percent of baby boomers have diversified retirement options. The percentage is much higher for younger employees.

What EMPLOYERS are saying about employee finances and retirement

A variety of recent studies have indicated that:

  • The top issues “addressed through financial wellness initiatives were healthcare costs and retirement preparedness.
  • 65 percent of employees participate in their employers’ retirement plan.
  • 80 percent of employers say that employee financial stress is reducing workplace performance, at an estimated cost of half a trillion dollars.

The missing retirement solution? (Hint: You may already offer it)

Despite all the options available, only 36 percent of non-retirees said in a 2019 survey that their retirement saving is on track. Meanwhile, HSAs are booming in popularity, with total assets eclipsing $82 billion in 2020. That’s nearly triple from just five years earlier.

HSAs have comparable — or better — perks than a 401(k) or IRA with respect to healthcare costs, including:

  • HSA contributions reduce taxable income.
  • HSA contributions made through payroll are not subject to the 7.65% FICA tax.
  • Withdrawals for HSA eligible medical expenses are tax-free.
  • HSA funds can be invested, and earnings through investment accumulate tax-free.
  • All HSA funds carry over from year to year.
  • Flexibility to withdraw funds for eligible medical expenses when needs emerge.
  • Generally, contribution amounts can be changed at any time.

These traits make the HSA a powerful, yet under-utilized investment and retirement tool.

How Popular Retirement Plans Stack Up

Eligibility 2021
contribution limits
Taxes – contributions Taxes – withdrawals Withdrawal
penalties

Traditional 401k

Must be employed at a business that offers a 401(k). $19,500 if you’re younger than 50. $26,000 for anyone 50 or older. Tax-free Taxed Generally, withdrawals prior to age 59 ½ are subject to be included in gross income, plus a 10% penalty.

Traditional IRA

Must have taxable compensation and be younger than 70 ½. Additionally, your deduction may be limited if you (or your spouse,
if you are married) are covered by a retirement plan at work and your income exceeds certain levels.
The lesser of:
$6,000 (or $7,000, for anyone 50 or older)
Your taxable compensation for the year.
Tax-free if they qualify (eligibility is based on your retirement plan at work) Taxed Generally, withdrawals prior to age 59 ½ are subject to be included in gross income, plus a 10% penalty.

Roth IRA

Can contribute at any age if you meet certain income requirements. The lesser of:
$6,000 (or $7,000, for anyone 50 or older)
Your taxable compensation for the year.
Taxed Tax-free if withdrawals qualify Generally, withdrawals prior to age 59 ½ are subject to be included in gross income, plus a 10% penalty.

HSA

Must be enrolled in a HSA qualified health plan. $3,600 self-only; $7,200 family. Additional $1,000 for anyone 55 or older. Tax-free, if made by payroll deduction Tax-free (if funds are used on eligible medical expenses at any age). Taxable as ordinary income after age 65 (if funds are used for any reason other than eligible medical expenses). Generally, withdrawals for ineligible expenses prior to age 65 are subject to be included in gross income, plus a 20% tax penalty.

Traditional 403(b)

Generally, an eligible employee of a public school system or church, or an employee of a Code
Section 501(c)(3) taxexempt organization are among those who qualify.
Employer limit: $19,500 for anyone younger than 50. $26,000 for anyone 50 or older. Employee/employer combined limit: $58,000 for anyone younger than 50; $64,500 for anyone 50 or older. Tax-free if they qualify (eligibility is based on your retirement plan at work) Taxed Generally, withdrawals prior to age 59 ½ are subject to be included in gross income, plus a
10% penalty.

Roth 403(b)

Generally, an eligible employee of a public school system or church, or an employee of a Code
Section 501(c)(3) taxexempt organization are among those who qualify.
Employer limit: $19,500 for anyone younger than 50. $26,000 for anyone 50 or older. Employee/employer combined limit: $58,000 for anyone younger than 50; $64,500 for anyone 50 or older. Taxed Tax-free if withdrawals qualify Generally, withdrawals prior to age 59 ½ are subject to be included in gross income, plus a
10% penalty.

See the HSA savings

Over half of HSA-enrolled employees also contribute to a 401(k). But there’s a reason why these employees should consider maxing out their HSA contributions before they contribute to a 401(k) or IRA.

Let’s lay out a scenario for someone, who we’ll call Jane Smith. Jane is married with two kids and is preparing for retirement by participating in an HSA, 401(k), and IRA.

  • She contributes $4,000 into each of these accounts: her family HSA, 401(k), and IRA.
  • She invests her HSA funds. The return-on-investment for each account is 5 percent annually.
  • Her combined federal and state tax rate is 25 percent, and her tax rate at the time she distributes funds is 15 percent.

Watch her funds grow:

That’s a 31 percent increase in healthcare purchasing power with an HSA after 20 years when compared to a 401(k) or IRA. So what happened?

  • 401(k) and IRA contributions are subject to FICA taxes (which are 7.65 percent), while HSA contributions are not.
  • With a 401(k) or IRA, funds are taxed somewhere, either when they’re contributed or when they’re withdrawn. With an HSA, funds are not taxed when contributed or withdrawn, as long as the purchases are for eligible healthcare expenses. This is huge. The average couple will spend over $350,000 on healthcare costs in retirement.

How Does An HSA Work After Age 65?

While HSA withdrawals are only tax-free when used on eligible expenses, that’s a significant need for your employees as they age. Healthcare costs are the third-largest expense for retiree households, behind only housing and transportation.

No penalties for ineligible expenses

When an HSA participant reaches age 65, they can pay for any expense with their HSA funds without facing a 20 percent tax penalty. For eligible healthcare expenses, the funds are spent tax-free like they always have been. For ineligible expenses, the funds would still be taxed.

Compare that with a traditional 401(k). If your retired employee withdrew funds, the funds would be taxed as income.

Paying for Medicare, long-term needs

Medicare is generally available to individuals once they turn 65. That opens up some added spending flexibility for those with an HSA. While HSA participants can’t contribute to an HSA while on Medicare, they can still withdraw funds.

If one of your employees purchases long-term care insurance, they can use HSA funds to pay for a variety of Medicare premiums and long-term care insurance premiums. However, there are limits on how much they can withdraw for long-term care insurance premiums.

Savings Scenarios

As we mentioned above, approximately $351,000 in today’s dollars ($535,000 in future dollars) is needed for the average couple to cover healthcare costs in retirement. That means an individual can expect to need half that — $175,000 — in retirement. We’ve outlined a few scenarios should an employee use their HSA entirely as a retirement-planning tool.

Scenerio #1

Kelsey is 25 years old and is 40 years from retirement.

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Scenerio #2

Juanita is 35 years old and is 30 years from retirement.

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Scenerio #3

Adam is 45 and is 20 years from retirement.

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Scenerio #4

Joe is less than 20 years from retirement.

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Changing the HSA/Retirement Conversation

We’ve outlined three easy ways to start changing the way you present HSAs to your employees below:


Communicate with retirement options

One reason that HSA participants typically use their HSA for short-term savings might be that they’re often communicated during open enrollment alongside FSAs and HRAs. After all, HSAs are health accounts. And the administrator of your HSA might also administer your FSA and HRA. But it’s important to also communicate HSAs when you’re discussing any available retirement options to your employees, such as an employer-sponsored 401(k) or pension plans.


Set the example, and they may follow

Many employers whet their employees’ appetites for 401(k) participation by matching funds. In 2018, employers contributed an average of 5.2 percent of employee salaries into a 401(k), which may have sparked an increase in employee contributions. If you offer an HSA, do you employees have any incentives to contribute? Provide them with a contribution or match to entice them to open and contribute to an HSA.


Emphasize retirement diversification

A diversified retirement approach isn’t limited only to diversified assets. Diversifying retirement accounts also makes sense, allowing each account to focus on a certain retirement need or a specific type of investment asset. HSAs are perfectly positioned to cover healthcare retirement costs. If someone is enrolled in an HSA, 401(k), and IRA, they could use the latter two to tackle other retirement needs, such as housing and transportation.

For more tips on how to talk about HSAs and encourage retirement preparation, download this handout.

Are HDHP Deductibles Really That High?

To participate in an HSA, your employees must be enrolled in a qualifying high-deductible health plan (HDHP). For those new to HDHPs, they might be hesitant. While HDHPs have perks beyond HSA eligibility, including lower premiums, they do have higher deductibles.

But your employees might be surprised by how little of a difference there is in deductibles between an HDHP and a traditional health plan.

2021 HDHP annual deductible minimum limit

Single – $1,400
Family – $2,800

Average annual deductible for a more traditional, non-high-deductible plan (based on 2018 survey)

Single – $932
Family – $1,931

Average annual deductible per enrolled employee in employer-based health insurance (in 2019 for any plan)

Single – $1,931
Family – $3,655

These numbers indicate that the average employer-based health insurance may already qualify as an HDHP. Even if your employees’ HDHP doesn’t qualify, it might not be far off from meeting that requirement. Plus, there are other factors to consider such as coinsurance and copays.

Meeting the high-deductible limit alone isn’t enough to make an HDHP eligible to be paired with an HSA.

Per IRS requirements, an HSA-eligible HDHP:

  • Has a maximum limit on the sum of the annual deductible and out-of-pocket medical expenses that you must pay for covered expenses.
  • According to the IRS, out-of-pocket expenses include copayments and other amounts, but not premiums.
  • May provide preventive care benefits without a deductible or with a deductible less than the minimum annual deductible.
    Can’t offer any benefit beyond preventive care until the deductible is met.

“What scares employees from enrolling in the HDHP is not having the fixed copay amounts (PCP, specialist and prescription benefits). However, depending on the plan design, there are cases where an HDHP’s out-of-pocket deductible is lower than it is for a traditional plan. We get through those concerns with employee education and showing that employer HSA funding will bring down the overall employee’s out-of-pocket maximum.”
– Beth Gavrel, Vice President Team Lead, Lockton Companies