HSAs can help with retirement
Few people understand how useful they can be.
What does health care have to do with retirement? Plenty, and there’s an investment vehicle out there that can help with it.
Health savings accounts could be an important option, though most people aren’t thinking of them for retirement. As their name implies, these vehicles are designed to help Americans stash away cash for medical expenditures. Most people use them for near-term costs while still employed. But medical bills also accumulate in retirement, and the money that builds up can be used to meet such costs, very efficiently.
The accounts allow for pretax contributions, tax-sheltered growth of investment dollars and tax-free withdrawals if used to pay for medical costs. They can help minimize taxes compared with taking withdrawals from other accounts, such as traditional Individual Retirement Accounts.
HSAs increasingly are included in benefits packages offered by employers. They also may be opened through the government health insurance marketplaces or exchanges. Either way, HSAs are designed for people who use highdeductible health insurance plans. With open-enrollment season here, now’s the time to investigate.
A new study by the Employee Benefit Research Institute found that while more Americans are turning to HSAs to meet medical expenses, relatively few use them for retirement planning.
The research was based on nearly 6 million HSAs with $13 billion in combined assets.
Largely underutilized
HSAs have been around since 2004 and thus don’t have as long of a track record as IRAs, including Roths, or 401(k)-style workplace retirement plans. More than three in four HSAs were established just within the past four years, according to the institute, a research group that focuses on health, savings and retirement issues.
Participants often use HSAs as a type of checking account, pulling out money to meet short-term health expenditures. Still, even these people typically withdraw less than they contribute, which explains how account balances continue to grow.
For accounts that received at least some contributions during 2017, the average balance rose to $2,764 at the end of the year, up from $1,873 at the start. HSA balances can be rolled over to future years.
Half of HSA owners contributed money in 2017, averaging $1,949, with employer contributions averaging $895, according to the study. But only 13 percent of individuals saved the full allowable limits.
Most account holders keep their balances in cash, further underscoring the checking-account feel. Those who invested in growth vehicles such as stock mutual funds and let their money compound had higher balances on average, according to the study. Mutual funds and exchange-traded funds are especially good choices for small HSA balances, providing broad diversification and allowing low minimum investments.
One thing to watch are fees: A Morningstar study last year said fees can be a problem, and they might exert a greater impact on low-yielding cash instruments.
Paul Fronstin, director of the health research and education program at EBRI and author of the group’s study, cited the need for employers and others to help participants recognize the investing potential of HSAs and the wisdom of socking away more money.
“With health care costs comprising such a large percentage of retirement expenses, the HSA should be viewed as an important retirement savings vehicle,” he said.
The accounts are flexible and portable, meaning you can move them among various investment firms. Aside from cash options, mutual funds are common choices, he said.
“For most people, they’ll look like their 401(k) plans,” Fronstin said, referring to the investment choices available.
For 2018, an individual could sock away up to $3,450 in an HSA, or $6,900 for family coverage, with people 55 and older able to invest another $1,000. Unlike IRAs, there’s no income eligibility with HSAs. In 2019, the investment limits will rise to $3,500 and $7,000, respectively.
Retiree health estimates
Most people will incur substantial health costs in retirement, for which HSAs can help.
The Center for Retirement Research at Boston College this year estimated a typical 65-year-old couple would need roughly $197,000 for health care spending in retirement. The EBRI itself assumed a 65-year-old couple would need $265,000, while Fidelity Investments projected that a couple, also starting at age 65, would need around $280,000. None of those estimates included potential costs for long-term care.
The Vanguard Group, with help from Mercer Health & Benefits, took a different tack, projecting a typical woman could face $200,000 in out-of-pocket medical costs starting at age 65 and ex- tending over her remaining estimated lifespan of 24 years. The costs are roughly 2 percent less for men, partly because they tend not to live as long.
But that report mostly focused on these costs as an annual expense, not as a lump sum, for which the yearly costs would be closer to $5,200 per person.
Value of HSA withdrawals
A key point here is to start using and funding HSAs now, while contributing close to the annual limits if you can. But don’t tap the accounts too early. Workers who elect to pay current medical expenses from regular income can allow money in their HSAs to accumulate. As noted, the money would build up and withdrawals would come out tax-free if used for eligible medical costs, the definition of which is pretty broad.
That last point, on tax-free withdrawals, deserves elaboration. Because money pulled from HSAs during retirement avoids taxes, unlike that from traditional IRAs, it wouldn’t cause problems if you already have started to claim Social Security retirement benefits.
Social Security benefits could be partly taxable if you have a significant amount of other income. Job earnings, pension withdrawals and traditionalIRA distributions are among the income sources that could trigger taxes but not those from Roth IRAs or HSAs.