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With health care open enrollment season quickly approaching, 401k plan sponsors may want to spend some time educating participants on the use of Health Savings Accounts (HSAs). If you offer a High-Deductible Health Plan (HDHP) to your 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.

Max Out HSAs First

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. And so on, forever. Well at least until the employee passes away. HSA balances are never forfeited due to lack of use during a year.

Retiree healthcare 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 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% 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:

1. 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.

2. Then, employees should fill up their HSA accounts using payroll contributions. The maximum annual contributions are outlined above.

3. 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.

4. 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 outlined above 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 HSA contributions each year and investing unused contributions so account balances can grow. If your HSAs don’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 your employees on their use.


About the Author

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.

About Lawton Retirement Plan Consultants, LLC

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 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at: https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

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, 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.