Recently we learned that rising healthcare costs are a challenge for Americans of all ages. One way to help deal with this particular type of inflation risk is to utilize a health savings account (HSA). Indeed, as a review, the Internal Revenue Service (IRS) defines an HSA as a tax-advantaged trust or custodial account that is set up with a qualified HSA trustee to pay or reimburse certain medical expenses. The main tax benefits of HSAs are that contributions are deductible from taxable income, contributions can grow (from interest or other capital earnings) tax free, and withdrawals are tax exempt as well, as long as for qualified medical expenses.
As a result, HSAs encourage setting aside money for the future and help people avoid having to dip into their long-term retirement savings in the event of an unforeseen medical expense. In order to take advantage of an HSA, individuals must be covered under a high-deductible health plan (HDHP), which rising medical costs and the Affordable Care Act’s “Cadillac tax” have forced many employers to use or at least consider. There are annual limits to what can be contributed to an HSA but the IRS earlier this month announced that the ceiling would be raised in 2018. More importantly, contributed funds roll over and accumulate year-to-year if they are not spent, therefore making HSAs a potentially powerful savings vehicle.
In fact, an earlier analysis by the Employee Benefits Research Institute (EBRI) estimated that an individual who saves in an HSA for just 10 years could accumulate between $53,000 and $68,000, depending on the rate of return realized and on the contribution rates assumed, and as much as $1.1 million over a 40-year horizon. A new study by Fidelity Investments also found that savings rates for employees participating in both a 401(k) and an HSA tend to be 2.4 percentage points higher than for individuals utilizing only a 401(k) plan. Further, 88 percent of participants in the Fidelity study who started contributing to an HSA maintained or increased their 401(k) savings rate after their HSA enrollment.
Fortunately, HSAs have become quite popular in recent years due to rapidly rising healthcare costs and the flexibility these savings vehicles provide employers as a benefits offering. A new study by the Plan Sponsor Council of America (PSCA) even found that more than two-thirds (71.5 percent) of surveyed U.S. employers currently offer an HSA to their workers. Roughly three in four (75.3 percent) respondents said that they view HSAs as an important component of their company’s retirement benefits strategy, and many employers described HSAs as a tool that can help workers accumulate savings. The latter is evidenced by the plurality of surveyed employers who indicated that only a quarter at most of their employees use up the entire HSA balance every year.
Sources: U.S. IRS, Kaiser Health News, EBRI, NAPA, Fidelity Investments, Benefits Pro, PSCAPost author: Charles Couch