Leverage Your Health Savings Account to Increase Your Options in Retirement

Health Savings Accounts provide both immediate and long-term financial benefits to owners who understand and harness their power.

Last Saturday, Oct. 15, was the fourth annual HSA Day. Since it fell midway between HSA Wednesday Wisdom publication dates, we divided the benefits of a Health Savings Account between the immediate benefits (last Wednesday) and today’s focus on long-term benefits.

Health Savings Accounts are a powerful financial ally. But the benefits - like those of other tools - are limited to those who understand how to harness the power of these accounts. HSA Day was created in 2019 to help average Americans understand how to extract the most value from this opportunity. Since then, Americans have opened eight million new accounts (a 30% growth rate) and grown their balances by about $35 billion (more than a 50% increase). Growth in the future will only continue as companies and workers look for more effective ways of covering medical expenses.

Let's look at some of the ways that Health Savings Accounts deliver value in the future.

Funding Retirement

Surveys consistently show that three-quarters or more of employees are overinsured on medical coverage. In simple terms, when they have a choice of plans, they choose an option that reduces their out-of-pocket costs at a higher premium. But their claims are low enough that they would have been better off financially paying a lower premium and accepting the higher out-of-pocket limit, which they didn’t reach.

Employees in this situation can redirect those payroll-deduction savings into contributions into either a Health Savings Account or a qualified retirement plan. Too often, employees consider each workplace benefit in isolation, rather than as a budget through whey can prudently buy less of some financial protection in exchange for more of another form of protection. Or, simply put in this case, they can forward less of their paycheck to their insurer and retain those funds, depositing them into either a Health Savings Account to pay for current or future qualified expenses or a qualified retirement plan to meet their financial needs in retirement.

Here’s how a Health Savings Account helps: When employees place the premium savings in a Health Savings Account, they build an emergency medical account to meet unexpected medical, dental, or vision expenses. With this balance available, they’re much less likely to look for cash in the only place that many Americans have liquid assets – their qualified retirement plan. Premature withdrawals are subject to taxes and penalties. And whether the source is a withdrawal or a repayable loan, the balance declines (permanently or temporarily), thus reducing growth in the account over time.

 Payroll Taxes

Health Savings Account pre-tax payroll deductions aren’t subject to federal payroll taxes. In contrast, the same contributions to any qualified retirement plan are taxed at 7.65% (1.45% on incomes below $147,000 in 2022). We noted last week that this savings represents an instant 7.65% return on investment.

Here’s how a Health Savings Account helps: Let’s focus this week not on the instant savings, bur rather on the difference over the long haul. If you divert $2,000 annually from a qualified retirement plan to a Health Savings Account and earn 6% compound annual interest, your payroll-tax savings equal $5,400 after 20 years and $11,400 after 30 years. Boost the contribution to $3,000 and you generate an additional $8,200 of retirement income after 20 years and more than $17,400 after 30 years. Those figures may not seem like much. But an additional $11,400 would buy five-and-a-half years of Part B coverage at the 2022 premium.

Control of Assets in Retirement

Many retirees don’t comprehend the true nature of their retirement-account partner, the federal government, until the year that they turn age 70½. Then, they’re required to take a minimum distribution, set by the government, from a tax-deferred account like a (non-Roth) 401(k) plan or Individual Retirement Arrangement (IRA). That Required Minimum Distribution (RMD) may not affect them because it’s less than what they must withdraw annually to fund their retirement.

There are times when a retiree may want to distribute less than the required minimum. For example, she may be flush with cash following the sale of a primary residence or investment. The stock market may be down, and she wants to support her lifestyle via withdrawals from a cash account and preserve her invested balances to grow more quickly when the market produces positive returns. But she must withdraw at least an amount set by a formula that considers her projected remaining lifespan and the value of her accounts.

Here’s how a Health Savings Account helps: RMDs never apply to Health Savings Account balances. The owner decides when, whether, and how much to withdraw from the account. That freedom may be worth thousands of dollars in tax savings.

Lower Medicare Premiums

Older Americans who enroll in Part B and Part D pay a monthly premium that reflects about a quarter of the cost of coverage (the remaining 75% is paid out of general federal revenues). That subsidy is reduced for enrollees with higher incomes.

Here’s how a Health Savings Account helps: Withdrawals from a Health Savings Account for qualified expenses don’t count as income. In contrast, distributions from a tax-deferred 401(k) plan or IRA does. If your income is close to pushing you into a higher tier and thus a higher Medicare Part B and Part D premium, a Health Savings Account can pay huge dividends.

Example: Samantha, age 68 and single, has spent a wonderful year traveling around the world. In early December, she sees that between Social Security and withdrawals from her tax-deferred IRA, her income is $150,000. If her income exceeds $153,000, her Medicare Part B premium will increase from $164.80 to $263.70. She has $5,000 in medical bills that she needs to pay before the end of the year. If she withdraws $5,000 from her IRA, her income will rise to $155,000 and she’ll be subject to RMDs and pay an additional $1,200 in annual Part B premiums two years later.

Think about that. An extra $1,200 in premiums that a Health Savings Account owner can avoid. Just by thinking ahead and allocating retirement savings differently.

Taxation of Social Security Benefit

Social Security benefits have been subject to federal income tax since the 1980s. Depending on your income, 0%, 50%, or 70% of your benefit is included in your taxable income. Only the lowest-income seniors will fall into the 0% tier. But the difference between 50% and 70% hits many seniors who rely solely on Social Security and a small pension or small distributions from an IRA. The average Social Security benefit is about $20,000 annually, so the difference between 50% and 70% of the benefit taxed is $4,000 of income. That’s a tax bill of $400 or more.

Here’s how a Health Savings Account helps: Health Savings Account distributions for qualified expenses aren’t included in income. Thus, paying a medical or dental bill from a Health Savings Account doesn’t raise a retiree’s income. In contrast, withdrawing the same amount for the same bill from a tax-deferred 401(k) plan or IRA does.

 The Bottom Line

Health Savings Accounts deliver value. If your employer offers a program and you haven't enrolled, it makes sense to consider whether this approach delvers greater financial benefit to you. The Health Savings Account program and the extra money that you can allocate to other forms of financial protection may not be the best allocation of your benefits dollars. But you'll never know if you don't take the time to understand your personal situation and look objectively at how to spend your annual allotment of employer benefits dollars.

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