Feasibility of HSAs as Retirement Savings Strategy

Recent reports have claimed health savings accounts (HSAs) can be a useful additional tool for retirement saving. But, how feasible is it that employees can accumulate savings in HSAs to use in retirement, and should employers consider offering them?

Research from the Employee Benefit Research Institute (EBRI) shows an individual who saves in an HSA for 10 years could accumulate between $53,000 and $68,000, depending on the rate of return realized and on the contribution rates assumed, while those saving for 20 years could wind up with between $118,000 and $193,000.

But, EBRI concedes that in order to maximize the savings in an HSA to cover health care expenses in retirement, HSA owners would need to pay the medical expenses they incur prior to retirement on an after-tax basis using money not contributed to their HSAs, and many individuals may not have the means to both save in an HSA and pay their out-of-pocket health care expenses.

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To offer employees HSAs, employers must pair them with high-deductible health plans (HDHPs). Bob Kaiser, head of Health Benefit Solutions for Bank of America Merrill Lynch in Charlotte, North Carolina, says there is value in this arrangement for employees and advantages for employers.

According to Kaiser, year-after-year, Bank of America Merrill Lynch’s CFO Outlooks show health benefit costs are a big concern for employers. HDHPs cut costs for employers, as employees pay a higher share of health care expenses through higher deductibles and higher co-insurance. Also, employers want employees to focus more on healthy behaviors and prevention of illness and disease; studies show HDHPs make employees more cost-conscious, and enrollees are more likely to take part in wellness programs. He says some employers are willing to contribute to employees’ HSA accounts to encourage participation in wellness initiatives.

Employees need to think about health care costs in retirement, Kaiser says. An EBRI study shows a couple that retires at age 65 can expect health care costs of more than $280,000. If an employee uses his 401(k) or 403(b) retirement plan savings for health care expenses, it will diminish savings that can be used for other living expenses or leisure, he notes. With an HSA paired with an HDHP, employees can put aside money each year for health care, they do not have to take required minimum distributions (RMDs) from those accounts, and the savings can continue to be invested and grow. In addition, when contributions and earnings are taken out to be used for medical expenses, they are not taxed.

Kaiser suggests that an HDHP should instead be called a low-premium health plan. “It is no different than what they would expect with house or car insurance—the higher the deductible, the lower the premium,” he says. Theoretically, the lower premium allows employees to take the difference in what they would pay in premiums and put that into the HSA.

To use HSAs to save for health care in retirement, ideally, an adviser may suggest, the employee should contribute enough to his retirement plan to maximize the employer match contribution then shift to putting the maximum allowed contribution into an HSA, according to Kaiser. He concedes that this is a good plan for the young and healthy, but there will be some who will spend their savings on current health care expenses.

Bill Heestand, president of The Heestand Company in Portland, Oregon, agrees that if the employee is young and healthy, he can accumulate savings in an HSA, but most employees are older or use regular medications, and those with families are going to the doctor more often than others, so the ability to have enough free cash flow to allow HSA savings to accumulate for retirement is hard to achieve.

Heestand also says most employers view health insurance as a competitive benefit, and they need to offer something that is much more supportive to employees. His firm recommends that if an employer wants to offer HDHPs with HSAs, they should fund the contributions 80% to 100%. Kaiser points out that EBRI found 71% of workers with HSAs say employers contribute to their accounts.

However, Heestand contends that even if employers fund almost 100% of participant HSA contributions, the accounts will likely be used by employees on an ongoing basis, and not used as savings for health care expenses in retirement. He suggests a legislative change to HSA rules would make them more viable as savings vehicles for retirement.

He notes that current HSA legislation prohibits the use of co-pays for doctor visits and prescription medications at all. Assuming it is reasonable a family could have a doctor visit for some member every other month, if Congress allowed for a co-pay for six doctor visits and 12 prescriptions, for example, the family would need to use less HSA savings. This could help a larger percentage of people accumulate HSA savings, Heestand says.

“Plan sponsors that are in an influential position should point that out. It would be a helpful conversation to get started,” he suggests.

Educating employees is important to their use of HSAs, Kaiser says. Presenting HSAs side-by-side with retirement plans as two factors in employees’ retirement savings strategy is helpful. But, even those employees who spend their HSAs on current medical expenses are saving money because they are using pre-tax funds.

A consultant can provide a holistic view of an employer’s health benefits offering to help them determine if they want to continue with current benefits or add an HDHP paired with HSAs, he suggests.

A TDF Glide Path Checklist

Target-date funds are the default of choice for many plan sponsors, says Russell Investments, but they aren't a buy-it-and-forget-it solution for sponsors or providers.

Russell Investments published a short white paper looking at key questions that can help plan sponsors make sure their target-date funds (TDFs) remain on course and serve participants’ best interest.

In the article, Josh Cohen, managing director of defined contribution, and Rod Greenshields, consulting director, argue that TDFs have become so popular because they don’t require much ongoing input from participants. However, the funds do need to be regularly updated by providers, Russell says, and sponsors have an ongoing fiduciary duty to make sure the products gel with participant needs. Otherwise, TDF models can drift out of touch with participant behavior or prevailing market conditions.

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Some factors for sponsors and plan fiduciaries to monitor include the impact of current market conditions on TDF model assumptions; whether TDFs are well-matched to real participants’ age demographics; the possible mismatch of income replacement goals and TDF model expectations; potentially unrealistic salary growth assumptions; and shifting regulatory requirements. These factors can impact the performance of a TDF over time, Russell says.

The research led to some modest changes to Russell’s glide path, John Greves, TDF portfolio manager for Russell, tells PLANSPONSOR. Perhaps the most significant change was that early stage equity allocations have increased slightly  to reflect lengthening lifespans and the rising costs of health care in retirement.

According to Greves, adding or subtracting just a few years in retirement age can make a big difference in retirement income needs—and therefore in retirement readiness. Every year of delaying retirement provides a twofold benefit by giving people one more year of savings opportunity, plus one less year of spending. In addition, Russell notes that delaying the need to claim Social Security can significantly increase the size of their monthly check.

At the same time, the actual retirement date can be a risky stage in an investor’s financial life, Greves says. From this point in time, new retirees must fund their retirement for the longest period, yet their influx of regular contributions will cease. For all these reasons, keeping a close eye on participant age demographics and how a TDF series addresses the numerous near-retirement risks faced by TDF users are key to satisfactory performance and fiduciary protection for sponsors.

Another issue is that many TDFs don’t identify an income goal, Greves notes. Now that DC plans are the predominant retirement plan for most American workers, the mindset of both plan sponsors and participants must shift toward a focus on retirement income goals, he says. Guidance can help participants define reasonable retirement spending based on salary levels, the contributions that they and their employers make, and the time horizon available to them.

Greves says Russell’s most recent TDF glide path adjustment used detailed income-needs research on retiree prescription drugs and long-term care expenses. The target replacement income was increased six percentage points to provide a cushion for such costs.

Another key question Russell urges sponsors to ask is, “How do the assumed contribution rates [underlying the TDF series model] compare to actual contribution rates?”

Employee behavior, employer matches and employer non-matching contributions all need to be taken into account when determining true contribution ability, Cohen and Greenshields write.

“For example, we took a close look at various matching structures when evaluating our glide path assumptions at Russell,” the pair explains. “Currently, the most common match structure in 401(k) plans is for the employer to match 50% of employee contributions up to 6% of employee earnings. Half of plan sponsors also make non-matching contributions at an average rate of 5% to 6% of earnings. Based on these findings, we raised our model’s contribution estimate to 9% early in a career and assume a gentle acceleration each year thereafter.”

This gets to another important challenge in analyzing and monitoring TDFs: Are the salary and salary growth assumptions realistic?

Greves explains that Russell recently updated its assumptions for the pattern of the total lifetime contributions of the average DC plan participant. He says salary assumptions need to account for some complex variations over the course of a career. For example, wages tend to be lower during the early years but grow more rapidly; they can be higher in later years, but the growth slows. Earnings growth may even be negative in real terms as participants approach retirement. A TDF glide path should be sophisticated enough to address these points.

Greves also points out that Russell’s strategic, long-term return assumptions for both equity and fixed-income asset classes have decreased materially from when the firm designed its first TDF glide path.

“Asset allocations embedded in today’s glide path must account for performance assumptions,” say Cohen and Greenshields. “Participants may need to take on more risk in order to have a realistic chance at a sufficient real return, and they may need to increase contributions to make up for lower returns.”

Cohen and Greenshields suggest that, for those already in retirement, low interest rates have pushed up annuity prices and long-term care premiums, while pushing down the amount of money retirees can withdraw each year. In response to this environment, Russell has modestly increased the allocation to growth assets in its glide path as part of an effort to improve participant outcomes, they explain. In the short term, markets fluctuate around projected long-term trend lines, so Russell believes portfolios also should be managed dynamically to improve the chance of reaching the desired outcome.

Finally, sponsors must ask whether asset allocations meet shifting regulatory requirements. As Russell explains, plan sponsors can designate an investment option as a default, which will prescribe an asset-allocation solution when participants make no other selection. To be designated as a qualified default investment alternative (QDIA), a TDF must fulfill multiple requirements, including having a mix of growth and capital preservation assets in all vintage year funds.

“Many in our industry default toward 90% growth and 10% capital preservation assets for younger participants,” Cohen and Greenshields write, “but we believe this allocation should be reconsidered as market conditions change. Russell has changed its TDF allocation to 93% growth and 7% capital preservation assets. This recognizes market conditions that have existed over the past few years, but is still designed to comply with Department of Labor regulations.”

The full Russell analysis is available here.

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