Market Watch – July 6, 2017 by Eileen Baldwin-Shaw
Want to provide a health benefit to workers and encourage employees to save at the same time? Offer a high-deductible health plan combined with a health-savings account; it accomplishes both goals and likely encourages retention, too.
This sounds like I’m mixing apples and oranges, but hear me out.
Founders at startups often agonize over retirement plans for employees. Not everyone can get stock options. But we know that 401(k) accounts and medical benefits can make the difference between keeping and losing an employee, especially if the company matches contributions.
One of the most common benefits being used by businesses are high-deductible health plans (HDHP). These plans have become popular when business owners are trying to both offer a health care benefit and manage the current and future costs of those benefits. These health insurance plans have lower premiums and higher deductibles. The current deductibles range from between $1,300 and $6,550 for an individual and $2,600 and $13,100 for a family.
The magic happens when you couple that plan with a health-savings account (HSA). This is a terrific savings option that a surprising number of people don’t understand.
The HSA contribution is tax-free or it is tax deductible if contributed after tax, not just tax-deferred like traditional 401(k) contributions to a retirement plan. Theoretically, the money can only be used for qualified medical expenses, but it’s not use-it-or-lose-it at the end of the year, like a flexible savings account (FSA). And the expenses that are reimbursable include dental and eye doctor visits.
With politicians battling over the fate of the Affordable Care Act and some data showing that couples may need as much as $350,000 to pay for health care in retirement, having some money stashed away for those expenses is appealing.
According to the 2016 Year-end Devenir HSA Research Report, the number of HSA accounts increased by 20% last year over the same time in 2015. HSA Investment assets reached an estimated $5.5 billion by the end 2016, which is still less than the roughly $7 trillion held in 401(k) plans at the end of last year.
The great thing about the HSA is that the contributions can grow, compound and are invested like a retirement account if an employee doesn’t deplete it and instead pays medical expenses out of pocket — which shouldn’t be difficult for those who are young and generally much healthier than older workers.
What some employees do is let the account grow with a plan to use it only if a medical catastrophe strikes. But having paid for medical expenses out of earnings for many of those early years, they find themselves sitting on a big, fat bundle of cash down the road. As long as you keep good records and can show out-of-pocket medical expenses that could have been reimbursed by your HSA, you can take the equivalent of those dollars and use them as you wish. There is no expiration.
Another attractive thing about the HSA is employees can take the account with them if they leave a company and even continue contributions until age 65, when the money can be withdrawn for any use without proof of medical costs. But if withdrawn for something other than medical expenses the money will be taxed at ordinary income rates. But before you start planning that dream vacation, a critical statistic to keep in mind is that, on average, a healthy 65-year-old couple will need $260,000 for out-of-pocket medical expenses in retirement.
Pairing a HDHP with an HSA is a great way for employers to make sure their workers have health care and are saving at the same time.
Individuals whose employers don’t offer an HSA, are freelancers, or even the unemployed can set up an HSA on their own — although the tax benefits aren’t as good. Annual contributions to HSAs are capped at $3,350 for single individuals and $6,750 for those with dependents enrolled in their insurance plans. Participants who are 55 and older can add $1,000. Incidentally, employers can make all, part or none of the contribution. Often, to encourage participation in the HDHP, employers will make a contribution to the employees’ HSAs. The employer contribution does count toward the annual maximum contributions.
An added benefit is that neither the employee nor the employer has to pay taxes on the contribution and no fiduciary duties exist.
So, voilà, you have a hassle-free and tax-free retirement plan.
For employers, as your company grows you can add traditional retirement plans and keep the HDHP and HSA as the sole option in your health plan or as one of many choices.
Willis Towers Watson, a benefits consulting firm, recently surveyed 600 U.S. companies and found that about half will offer HDHP plans exclusively.
If employees are offered both a 401(k) and an HSA, I generally recommend that they fully participate in the 401(k) up to the maximum amount of deferrals being matched. Then they should contribute to the HSA. If they have more money to save after the HSA limit is reached, go back to the 401(k) and fund to the maximum limit.
Until recently, HDHP/HSAs were mostly low-interest savings accounts and lacked higher-yielding investment choices. But that is fast changing and many investment options now exist.
For small-business owners this is a simple, out-of-the-box way to beef up a bare-bones benefits package — and save some time and money. For employees, it’s a tax-free way to save for the future, whatever it may be.
Eileen Baldwin-Shaw is an ERISA consultant heading up First Western Trust’s Third Party Administrative Services practice.