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Help Your Clients Turn a Triple Play With an HSA
Help your clients understand their options for saving for health care costs in retirement.
Chances are, you’ve encountered clients who have kept working because they were afraid they wouldn’t have enough money for their medical bills in retirement. Fortunately, there are now more ways than ever to save for these expenses.
Depending on the situation, your clients may be able to use an employer-sponsored pretax account, an employer-sponsored Roth account, or a health savings account (HSA) to meet health-related costs in retirement. By explaining these savings options, you can help your clients plan for the future—and put their minds at ease.
You can also share research from T. Rowe Price to help calm their fears about retirement health care costs. A New Way to Calculate Retirement Health Care Costs by Sudipto Banerjee, Ph.D., vice president, Retirement Thought Leadership, shows that medical costs for most retirees are quite manageable.
A comparison of health care savings options
As with many personal finance issues, an individual’s unique circumstances should guide which savings option(s) they choose for retirement health care costs. The following chart compares pretax accounts, Roth accounts, and HSAs.
A Comparison of Health Care Savings Options
Reflects Roth and pretax employer-sponsored plans (as opposed to IRAs) unless noted. Advantages of account type (relative to the others) shown in blue. These are not the only options when it comes to saving for health care and/or medical-related expenses in retirement. Note that while HSAs are structured for the individual to save or invest for health costs, this is not the intended primary purpose of a defined contribution plan or IRA. Individuals should evaluate their health coverage needs and other factors before seeking tax benefits of an HSA. Source: IRS documents.
The advantages of pretax versus Roth
Employer-sponsored pretax and Roth accounts are retirement savings vehicles with their own unique tax benefits:
- Pretax contributions to an employer-sponsored account can be deducted from and, therefore, reduce taxable income.
- Distributions from a Roth account are generally tax-free.
HSAs: The best of three worlds
HSAs combine the best of the pretax and Roth options. HSA proponents call it the "triple-tax benefit": tax-deductible contributions, tax-deferred growth, and tax-free qualified distributions. Unlike the other two options, HSAs can also be used for medical expenses before retirement without incurring a tax penalty.
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HSAs have been around since 2004. They are designed to help individuals save for medical expenses and, therefore, have much lower annual maximum contributions than pretax and Roth accounts. HSAs have become increasingly popular, with over 36 million accounts and $104 billion in assets as of the end of 2022.1 Given the tax advantages of these accounts, this growth is expected to continue.
What your clients need to know about HSAs
While HSAs can be a great savings tool for medical expenses, it’s essential that these accounts are used appropriately. If you’re discussing HSAs with your clients, here are key points to communicate:
- HSAs are only available with a high-deductible health plan.
- With a hefty 20% penalty on early nonqualified withdrawals, HSAs should not be used as an emergency fund unless it’s a last resort.
- If retirement plan contributions are matched by the employer, it usually makes the most sense to prioritize the matching contribution over the HSA.
- Medical expenses that can be paid from an HSA are usually the same as those that would qualify as federal income tax deductions.
- Qualified medical expenses from prior years can be used to take qualified distributions. The expenses need to have occurred after the HSA was established and cannot have been otherwise reimbursed or used for itemized deductions.
- When someone is young, it may make sense to invest long-term HSA contributions in asset classes with higher potential returns, such as equities. As they approach retirement, it may make more sense to reduce the risk in the portfolio to prepare for distributions to meet medical expenses.
Thoughtfully leveraging the unique benefits of HSAs can provide significant benefits to individuals. With tax-deductible contributions, growth, and qualified distributions, these accounts are a rare triple play for your clients.
1 Federal income taxes. State laws vary. HSA contributions through an employer may be excluded from FICA taxes.
2 Once you reach age 59½ with an account that has been opened for at least five years, you may qualify for tax-free withdrawals of both Roth contributions and any accumulated earnings.
3 HSA distributions are considered qualified if they are used to pay for Qualified Medical Expenses (QME).
4 Penalties end at age 65 for HSA and generally at age 59½ for Roth and Pretax. Distributions of contributed assets from Roth accounts are tax- and penalty-free. Early distributions from retirement plans or IRAs may be subject to taxes and penalties unless an exemption applies. HSA distribution penalty is applicable to distributions that are not used to pay for Qualified Medical Expenses (QME).
5 The SECURE 2.0 Act of 2022 was signed into law in late December 2022 and changes the Required Minimum Distribution (RMD) age to 73 for individuals who turn 72 on or after January 1, 2023. By April 1 following the year you reach age 73, you must begin to withdraw a certain amount of money annually from your pretax retirement account(s). If you are still working with the company that sponsors your plan, you may be allowed to delay your first RMD until the April 1 following the year in which you retire. For each year following the year you reach your RMD age (or retire, if later—as applicable) the deadline is December 31. The SECURE 2.0 Act of 2022 provides that the RMD age will change again to 75 in 2033.
6 Devenir Research, 2022 Year-End HSA Market Statistics & Trends Executive Summary. Accounts are rounded to the nearest million and include both funded and non-funded accounts, and assets are rounded to the nearest billion and include both deposits and investments.
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