With health care open enrollment season approaching, individuals electing a High-Deductible Health Plan (HDHP) will soon have an opportunity to decide how much to contribute to their Health Savings Account (HSA) for next year.
Contribute as much as you possibly can. And prioritize your HSA contributions ahead of your 401k contributions. I believe that employees 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. When balances are used to pay qualified health care expenses, the money comes 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 401(k) contributions, HSA contributions made from payroll deductions are truly pre-tax in that Medicare and Social Security taxes are not withheld. Both 401(k) pre-tax payroll contributions and HSA payroll contributions are made without deductions for state and federal taxes.
No use it or lose it
You may confuse HSAs with flexible spending accounts, where balances not used during a particular year are forfeited. With HSAs, unused balances carry over to the next year. And so on, forever. Well at least until you pass away. HSA balances are never forfeited due to lack of use.
Paying retiree health care expenses
Anyone fortunate enough to accumulate an HSA balance that is 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 Medicare premiums, long-term care insurance premiums, COBRA premiums, prescription drugs, dental expenses and, of course, any co-pays, deductibles or co-insurance amounts for you or your spouse.
HSA accounts are a tax-efficient way of paying for health care expenses in retirement, especially if the alternative is taking a taxable 401(k) or IRA distribution.
No age 70 1/2 minimum distribution requirements
There are no requirements to take minimum distributions at age 70 1/2 from HSA accounts as there are on 401k and IRA accounts. Any unused balance at your death can be passed on to your spouse (make sure you have completed a beneficiary designation so the account avoids probate). After your death, your spouse can enjoy the same tax-free use of your account. (Non-spouse beneficiaries lose all tax-free benefits of HSAs).
Maximum annual HSA contribution limits (employer plus employee) for 2019 are modest — $3,500 per individual and $7,000 for a family. An additional $1,000 in catch-up contributions is permitted for those age 55 and older.
Legislation has been proposed to increase the amount of allowable contributions and make usage more flexible. Hopefully it will pass.
HSAs and retirement planning
Most individuals will likely benefit from the following contribution strategy incorporating HSA contributions and 401k accounts:
1. Determine and make the maximum contributions to your HSA account via payroll deduction. The maximum annual contributions are outlined above.
2. Calculate the percentage that allows you to receive the maximum company match in your 401k plan. Make sure you contribute at least that percentage each year. There is no better investment anyone can make than receiving free money.
You may be surprised that I am prioritizing HSA contributions ahead of employee 401k contributions that generate a match. There are good reasons.
Besides being triple tax-free and not being subject to age 70 1/2 required minimum distributions, these account balances will likely be used every year. Unfortunately, you may die before using any of your retirement savings. However, someone in your family is likely to have health care expenses each year.
3. If the ability to contribute still exists, then calculate what it would take to max out your contributions to your 401k plan by making either the maximum percentage contribution or reaching the annual limit.
4. Finally, if you are still able to contribute and are eligible, consider contributing to a Roth IRA. Roth IRAs have no age 70 1/2 minimum distribution requirements (unlike pre-tax IRAs and 401k accounts). In addition, account balances may be withdrawn tax-free if certain conditions are met.
The contributions outlined above do not have to be made sequentially. In fact, it would be easiest and best to make all contributions on a continual, simultaneous, regular basis throughout the year. Calculate each contribution percentage separately and then determine what you can commit to for the year.
Investing HSA contributions important
The keys to building an HSA balance that carries over into retirement include maxing out HSA contributions each year and investing unused HSA contributions so account balances can grow. If your HSAs don’t offer investment funds, talk to your human resources department about adding them.
HSAs will continue to become a more important source of funds for retirees to pay health care expenses as use of HDHPs becomes more prevalent. Make sure you maximize your use of these accounts every year.
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 email@example.com.
Lawton Retirement Plan Consultants, LLC (LRPC) 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 employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly $475 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or firstname.lastname@example.org or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges, and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice, and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.