With healthcare open enrollment season quickly approaching, 401k plan advisors and sponsors may want to spend time educating participants on the use of health savings accounts (HSA).
If they offer a high-deductible health plan (HDHP) to employees, they probably have the ability to contribute to HSAs. I believe that nearly everyone eligible to contribute to an HSA should max out their HSA contributions each year. Here’s why:
HSAs are triple tax-free
HSA payroll contributions are made pre-tax and when balances are used to pay qualified health care expenses, they come out of HSA accounts tax-free. Earnings on HSA balances also accumulate tax-free. There are no other employee benefits that work this way.
HSA payroll contributions are truly tax-free
Unlike pre-tax 401k contributions, HSA contributions made from payroll deductions are truly pre-tax in that Medicare and Social Security taxes are not withheld. Both 401k pre-tax payroll contributions and HSA payroll contributions are made without deductions for state and federal taxes.
No use it or lose it
Employees may confuse HSAs with flexible spending accounts, where balances not used during a particular year may be forfeited. With HSAs, unused balances carry over to the next year, or at least until the employee passes away. HSA balances are never forfeited due to lack of use during a year.
Retiree health care expenses
Anyone fortunate enough to accumulate an HSA balance carried over into retirement may use it to pay for many routine and non-routine health care expenses.
HSA balances can be used to pay for prescription drugs, medical premiums, COBRA premiums, dental expenses, Medicare premiums, long-term care insurance premiums and of course any co-pays, deductibles or co-insurance amounts.
There are no age 70 1/2 minimum distribution requirements on HSA accounts like there are on 401k and IRA accounts. This makes HSA accounts a much more tax-efficient way of paying for health care expenses in retirement, especially if the alternative is taking a taxable 401k or IRA distribution.
Contribution limits
Maximum annual HSA contribution limits (employer plus employee) for 2018 are modest—$3,450 per individual and $6,900 for a family. Another $1,000 in catch-up contributions is permitted for those age 55 and older. Studies show that more than 80 percent of employers make some sort of contribution to HSAs for their employees.
HSAs and retirement planning
Most employees would likely benefit from the following contribution strategy incorporating HSA and 401k accounts:
- First, employees should contribute the percentage that allows them to receive the maximum company match in their 401k plan. There is no better investment any employee can make than receiving free money.
- Then, employees should fill up their HSA accounts using payroll contributions. The maximum annual contributions are outlined above.
- If the ability to contribute still exists, employees should then max out their contributions to their 401k plan by making either the maximum percentage contribution or reaching their annual limit.
- Finally, if employees are still able to contribute and are eligible, they should consider contributing to a Roth IRA. Roth IRAs have no age 70 1/2 minimum distribution requirements (like pre-tax IRAs and 401k accounts). In addition, account balances may be withdrawn tax-free if certain conditions are met.
The contributions do not have to be made sequentially. In fact, it would be easiest to make all contributions on a continual, regular basis throughout the year.
Employees should calculate each contribution percentage separately and then determine what they can commit to for the year.
The keys to building an account balance that can carry over into retirement include maxing out contributions each year and investing unused contributions so account balances can grow. If an HSA doesn’t offer investment funds, think about adding them soon.
HSAs will continue to become a more important source of funds for retirees to pay health care expenses as high-deductible health plans become more prevalent. Make sure you educate employees on their use.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Lawton is an award-winning 401k investment adviser with over 30 years of experience. Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to 401k plan sponsors. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or bob@lawtonrpc.com.
