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The retirement market continues to be dominated by 401(k)s. They are the centerpiece of the employer offering and the starting point for most financial advisors. But with a new year, is it time for a new approach to retirement benefits and savings? It's not often that we need to rethink our approach to retirement savings But it's well overdue. Especially after a year of economic uncertainty due to COVID-19. In fact, 31% of households withdrew money from their 401(k) and 27% borrowed against it during COVID. This is not to say that you should look to replace the 401(k), but it does mean complementing that approach to combat increasing retirement concerns and the retirement gap of employees is the new mandate.
Bring the HSA to the forefront of your retirement offering
Finding room in IRS regulations to increase the savings potential for employees feels like searching for a needle in a haystack. While there are well-known retirement saving options, there are still less understood tax-vehicles like HSAs that have been overlooked – at least from a retirement perspective.
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HSAs were designed as a tax-free savings vehicle specifically for health-related expenses. Their IRS regulations however make them equally designed as a premier retirement account. From a purely tax-centered perspective, they have more flexibility and tax advantages than a 401(k). Their only tax savings limitations are the yearly contribution limits and health plan requirements.
2021 HSA contribution limits are $3,600 for individuals and $7,200 for families.
Quick HSA overview
An HSA is a personal savings account for health expenses. HSAs are an easy and smart way to pay for qualified medical expenses for the account holder and their dependents. It's owned by the individual and is theirs for life. Think of an HSA like a 401(k) for healthcare. An HSA can be used to pay for healthcare costs today, in the future, or used as a savings vehicle for retirement. Contributions are 100% tax-deductible (until the maximum contribution limit is reached), and HSAs are triple tax-advantaged: tax-deductible contributions, tax-free interest, and tax-free withdrawals for qualifying medical expenses.
The account holder can contribute into an HSA when enrolled in a qualifying high-deductible health plan (HDHP), traditionally known for lower premiums and high-deductibles. A qualifying HDHP has a minimum deductible and out-of-pocket maximum that is set annually by the IRS. Full eligibility details can be found here.
Understanding the health plan eligibility is required, adding an HSA means families can save up to an additional $7,200 in 2021. Combined, that's $26,700 in tax-free contributions for 2021, regardless of income level.
That's a 37% increase on top of the $19,500 available from a 401(k). Employees over 55 can add an additional $1,000 in HSA and $6,500 in 401(k) catch up contributions to extend their tax-savings further.
This not only impacts the yearly tax savings, but also increases tax-savings next year and well into retirement. We will walk you through those scenarios.
Retirement saving scenarios
Adding an HSA to a retirement savings strategy has two direct financial and tax benefits:
- The added yearly tax-savings is already clear. Over a 30 year period and with continued maximized yearly contributions (at 2021 levels), that combined HSA savings balloons to over $330,000 (assumes 3% annual growth). This money can be used just like a 401(k) after the age of 65.
- Having HSA savings, on top of 401(k) savings, allows the account holder to save even more when considering expected medical expenses in retirement. HSA distributions, unlike 401(k) distributions are still 100% tax-free if used for qualified medical expenses. These are now expected to exceed $295,000 per couple in retirement. Those costs are on top of medicare coverage. The more money that can be used to pay for those costs tax-free, the bigger the total applied savings.
One interesting note that is not considered in the savings outline above is that employees who have both a 401(k) and HSA on average have a 42% increase in savings over 20 years (vs. 401(k) only savings). Participation in both plans has a direct impact on each individual plan. The combined average savings is also much larger than when an individual saves for a 401(k) or HSA only. In dollars, that amounts to $265,00 in projected savings vs. $187,00 in projected savings.
The savings impact
Rethinking the positioning of HSAs, and their immediate and long-term impact on retirement savings, opens up how employers and employees should approach their retirement benefits.
That should also change when and how the HSA is introduced to employees. Starting with the HSA, ahead of health plan selection, is a requirement to ensure eligibility, which opens up added tax-savings benefits.
The combined 36% tax savings from payroll deductions has an immediate impact on yearly savings, but the financial impact echoes and should increase year-over-year. 36% is the starting point, the combined tax advantages of an HSA and 401(k) create unforeseen and unanticipated flexibility in an otherwise stringent IRS regulatory framework.
Delaying this offering another year would negatively impact employees savings options for years to come.
Shobin Uralil is the COO and Co-Founder of Lively.
Disclaimer: the content presented in this article is for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.
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