HSAs Can Be Like DC Plans for Retirement Health Costs

As the increase in health care costs continues to the surpass the rate of inflation, the use of health savings accounts (HSAs) has increased with the adoption of consumer-directed health care plans by employers.

Alongside this trend, the retirement industry is starting to tout the additional benefits of HSAs as retirement planning tools.

“Most of Americans are unprepared for health care costs in retirement, and an HSA is the best way to save for that,” said Eric Roberts, a consultant at Nyhart Actuary & Employee Benefits, during a webcast hosted by the Healthcare Trends Institute. He noted that HSAs offer triple tax benefits, and at age 65, Medicare premiums and Medigap coverage are added to the eligible expense list for HSAs.

In addition, at age 65, the 20% distribution penalty for non-medical distributions no longer applies, so those distributions are taxed regularly. Required minimum distributions (RMDs) are not required from HSAs, and HSAs are not taken into account for Social Security means testing.

According to Roberts, many employees mistakenly believe HSAs are like flexible-spending accounts (FSAs); with FSAs, if they don’t use their funds by the end of the year, they will lose them. But, he said employers need to help employees develop a new mindset; they can put more into the HSA each year than they will need and the investment will grow, just like in their defined contribution retirement plan.

Roberts even suggests employees move some of their savings dollars from their DC plan to an HSA, as long as they still get the maximum employer match contribution from their retirement plan. For example, if an employee’s DC plan matches up to 6% of his or her deferrals, and that employee is contributing 10% to the retirement plan, he or she could take 4% of the DC plan contributions and put them into an HSA instead.

And this is not exactly a wash, Roberts explains, because HSA distributions for medical expenses are tax-free, and if the employee had to take a distribution from the DC plan, the distribution would have to be enough to also cover taxes.

President of HSA Consulting Services Todd Berkley told webcast attendees that employers can even default employees into contributing to an HSA, with the opportunity to opt out, and the Department of Labor (DOL) says that is ok to do without the HSA becoming an Employee Retirement Income Security Act (ERISA) plan.

Of course, the key to growing HSA savings is to invest the money.   

Berkley said the investment component of HSAs is “a hidden gem.”  Not all HSAs offer investments, but investments have been widely available and underutilized. He cited research that found after two years in HSAs, only 1.4% are investing, but after five years, 5.6% are investing, and by year eight, 10.5% are.

Focused education will help, Berkley said, and several HSA trustees as well as financial advisers have begun to highlight this capability to employees.

“Investing HSA assets is no different from investing DC plan assets,” Roberts added. “Employees just need to be made aware they can invest them.”

According to Berkley, some plans offer an HSA investment menu that is a modified version of the DC plan investment menu, and some HSA trustees offer open architecture with no restrictions on what investments can be used. He said an employer can offer the same investment menu as the DC plan; as long as the participant can decide whether to invest as well as how, the HSA is not an ERISA plan.

However, Roberts noted that any time employers make decisions about what investments to offer, they should be thinking about the best interest of participants, using the same fiduciary decision-making process as for the DC plan.

“I think we will see more employees viewing HSAs as a way to set aside dollars for retirement, and we need to educate along those lines,” Roberts concluded.