As the number of executive benefits decrease, it is becoming more important that your executive’s maximize the ones that still exist.
If you offer a high-deductible health plan (HDHP) to your employees, all of your executives should max out their contributions to their health savings accounts (HSAs) every year. Read on to learn why this is becoming one of the most important executive benefits.
Why Funding HSAs for Retirement is Important
HSA contributions are triple tax-free
HSA payroll contributions are made pre-tax. Earnings on HSA balances accumulate tax-free. When balances are used to pay qualified healthcare expenses, the money comes out of HSAs untaxed. There are no other employee benefits that work this way.
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.
HSAs aren’t “Use it or lose it”
It is easy to confuse HSAs with flexible spending accounts (FSAs) 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 the account holder passes away. HSA balances are never forfeited.
No minimum distributions at age 72 are required
There are no requirements to take minimum distributions at age 72 from HSAs as there are on 401k and IRA accounts. Any unused balance at the account holder’s death can be passed on to a spouse.
After the account holder’s death, a spouse can enjoy the same tax-free use of the account. However, non-spouse beneficiaries lose all tax-free benefits of HSAs.
Balance can be used for retiree healthcare
Building a significant HSA balance is not only important from the perspective of paying for healthcare expenses as an active employee. In addition, account balances can be used to pay for healthcare expenses in retirement. This may allow a retired executive to avoid using taxable 401k or IRA balances to pay healthcare expenses.
Accounts are portable
HSAs are completely portable. It doesn’t matter where an executive works or how many times he/she changes jobs. An HSA always remains with the individual.
How Your Executives Should Fund Their HSAs
Contribute the maximum
Maximum annual HSA contributions are modest — $3,550 per individual or $7,100 for a family for 2020. An additional $1,000 in catch-up contributions is permitted for those over age 55.
The key to building an account balance that carries over into retirement is 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 this year.
Consider an IRA rollover
A one-time option to rollover an IRA account balance into an HSA is available. The rollover is subject to testing and contribution limits, so individuals interested in taking advantage of this once per lifetime transfer should consult a tax expert.
Rolling an IRA balance into an HSA makes the most sense with traditional (pre-tax) IRA accounts. Rollovers are not taxed and balances can be withdrawn from HSA accounts tax-free. A rollover will also allow the account holder to avoid required minimum distributions on the IRA balance.
Try this strategy for integrating HSA and 401k contributions
Most executives will benefit from the following contribution strategy that maximizes the use of employee contributions to both HSA and 401k accounts:
1. Determine and make the maximum contributions to the executive’s HSA via payroll deduction. The maximum annual contributions are outlined above.
2. Calculate the percentage that allows the executive to receive the maximum company match in your 401k plan. Make sure they 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 more tax-efficient (triple tax-free) and not being subject to age 72 required minimum distributions, HSA balances will likely be used every year. Unfortunately, an individual may die before using any retirement balances. However, someone in an executive’s family is likely to have healthcare expenses each year.
3. If the ability to contribute still exists, then calculate what it would take to max out the executive’s contributions to your 401k plan by making either the maximum percentage contribution (if your executive group is limited by non-discrimination testing) or reaching the annual limit.
4. Finally, if an executive is still able to contribute and is eligible, consider contributing to a Roth IRA. Roth IRAs have no age 72 minimum distribution requirements (unlike traditional pre-tax IRA 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 simultaneous basis throughout the year. Calculate each contribution percentage and then determine the amounts that should be contributed each pay period.
Remember to invest HSA contributions
The keys to building an HSA balance that carries over into retirement are maxing out HSA contributions each year and investing unused HSA balances so the account grows.
Using HSA Balances in Retirement
Paying retiree healthcare expenses
Executives fortunate enough to accumulate an HSA balance that is carried over into retirement may use it to pay for many routine and non-routine healthcare expenses.
HSA balances can be used to pay for Medicare premiums, long-term care insurance premiums, COBRA premiums, prescription drugs, dental and vision expenses and, of course, any healthcare co-pays, deductibles or co-insurance amounts for the executive and spouse.
And, as a result of the recent CARES Act, HSA balances can now be used to pay for over-the-counter medications.
HSAs are a much more tax-efficient way of paying for healthcare expenses in retirement than taking taxable 401k or IRA distributions.
Using HSA balances for non-healthcare expenses after age 65
Before age 65 any withdrawals from an HSA that are not used to pay for healthcare expenses are subject to state and federal tax and a 20% penalty tax. After age 65, funds withdrawn from HSAs that are not used for health-related expenses are still subject to state and federal tax but do not incur a 20% penalty.
HSAs will continue to become a more important source of funds for retirees to pay healthcare expenses as use of HDHPs becomes more prevalent. Ensure that your executive’s maximize the use of these accounts.
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 is also an award-winning business writer having written for many organizations including Forbes and SourceMedia. Mr. Lawton may be contacted at (414) 828-4015 or firstname.lastname@example.org.
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 a half billion dollars in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or email@example.com 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.