Benefits programs today require employees to take personal responsibility and navigate increasingly complex systems. Plan sponsors play a crucial role by providing the right options and guidance to employees. This role is particularly important when it comes to helping meet two basic and intertwined employee needs: to manage health care expenses and maximize retirement savings.
In recent years, Capital Group’s retirement strategy team has seen growth in health saving accounts (HSAs), accounts which give employees a tax-advantaged way to save and invest for future medical expenses. This could be a critical aspect to closing the retirement readiness gap.
How HSAs can—and should—be used for retirement saving
If invested and grown over a number of years, HSAs can position retirees to better absorb rapidly rising health care expenses. Most people underestimate the cost of Medicare premiums, deductibles and medications. HSAs can help offset those anticipated and unanticipated costs. In combination with a qualified health plan, an HSA offers several advantages over using defined contribution (DC) plan distributions to pay for health care. These include:
- Triple-tax-free status.Employees contribute to HSAs with pre-tax money. Principal and earnings are not subject to taxation, and—unlike with 401(k) plans—distributions are not taxed if used for qualified medical expenses.
- “Stow it and Grow it” feature.While HSA assets can be used, without penalty, at any time for qualified health care expenses, unused balances can accumulate in the account and be invested for future benefit. As with their DC plan, employees can contribute to the HSA and invest for the long term. Employers often contribute to HSAs, and the employee can invest that money. HSAs can be used for a wide range of health care costs, and employees can contribute to them up to age 65.
- Helps protect and extend your retirement savings. While there are limits to annual contributions, there are no limits on how much can be invested and retained in the account. HSAs can be used for both short-term investments, i.e., to help cover one year of maximum health care insurance deductibles, and for the long-term, i.e., to invest for growth to support overall financial wellness.
As HSAs increase in importance, plan sponsors have been considering the investment options similarly to how they approach investment options in their DC plan. There are a number of ways to arrange an HSA menu, which can help a sponsor identify the right option for its employer, and ultimately for the employees. These include:
- 401(k) mirroring. The sponsor offers a core investment menu similar to its DC plan; this organizes the benefits package for employees and simplifies the due diligence process for employers.
- A mix of investmentoptions. A participant’s risk and financial situation are highly individualized, so the menu should contain a range of choices, certainly some that focus on stable investments.
- Target date. Early in their careers, enrollees have a longer time horizon and higher risk tolerance, with growth of assets as an objective. As they age, risk tolerance would decrease as they transition toward and into retirement. In retirement, an HSA enrollee would be focused on liquidity and stability as he starts to spend the assets. Those investment goals may be well-aligned with a target-date series that would follow very similar objectives and investment allocation.
Engaging with participants to maximize financial wellness benefits
Robust education programs are needed to help employees fully understand the potential benefits of HSAs. As plan sponsors continue to have these conversations, here are some key pointers that should help:
- Clearly distinguish HSAs from other health savings vehicles. Surveys show that many employees confuse HSAs, which can be rolled over from year to year, with “use-it-or-lose-it” flexible spending accounts (FSAs).
- Explain the differences in tax treatment between HSAs and 401(k) plans.
- Outline ways to distribute contributions among HSAs, 401(k) plans and other benefits. For example, employees might first put enough in the retirement plan to maximize the employer match, then put enough in an HSA to meet the minimum deductible, and then contribute to other pre-tax benefits.
- Suggest milestones for employees to consider when investing their HSAs—such as having enough in the account to cover the maximum deductible or the maximum out-of-pocket amount before investing any HSA assets.
Employees are concerned about financial wellness, including how to manage health care costs. Employers can help their employees maximize benefits while protecting retirement plan assets. Plan sponsors should think about financial wellness holistically. We can no longer look at retirement as limited solely to the retirement plan but as an integrated solution with health care, maximizing plan benefits and investment solutions.
Sue Walton is a senior retirement strategist at American Funds, part of Capital Group. She has over 20 years of industry experience and has been with Capital Group for three years.
American Funds Distributors, Inc.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Strategic Insight or its affiliates.
« Trade War Effects on Retirement Plans