Advisers must help clients decide how HSAs fit in their plans

Health savings accounts, as reported in the Dec. 1 issue of InvestmentNews, offer financial advisers and their clients a planning opportunity, and a new planning complication.

The opportunity is the chance to set aside money on a tax-advantaged basis to pay for medical costs not covered by the high-deductible health plans being put in place by many employers as they phase out traditional medical insurance plans. They are also offered in the health insurance marketplaces established under the Affordable Care Act.

The complication is that clients must find the money to set aside into the HSAs when many are already struggling to maximize their contributions to the 401(k) plans that have replaced defined benefit pension plans over the past two decades.

Basically, employers have foisted the problem of saving for retirement and for paying for many medical expenses on to employees. Congress has provided vehicles to make that easier for employees with tax advantaged 401(k)s and HSAs.

HSAs were established in 2003 as part of the Medicare Prescription Drug Improvement and Modernization Act when Congress recognized the trend of employers reacting to ever-rising medical insurance costs by instituting high-deductible plans. According to a Kaiser Foundation survey, in 2014 80% of covered employees were covered by high-deductible health insurance plans.

As more and more employers have implemented such plans with higher and higher deductions, the HSA opportunity has become more important.

In 2014 employees could contribute up to $3,000 to their HSAs if single, and up to $6,600 for a family, and those over 55 could contribute an additional $1,000. Those amounts rise in 2015 by $50, except for the catch-up contribution which remains unchanged.

The contributions can be invested in a manner similar to individual retirement accounts. Investment earnings are sheltered from taxation, and can be withdrawn without tax consequences to pay for qualified medical expenses.

Unfortunately, the Act provided no new resources for employees to set money aside, and many, if not most, need help in deciding how to allocate their limited savings between the retirement savings and health savings.

The first question that employees must answer, and the question financial advisers can help them answer, is where will the money for the HSA contribution come from?

Financial advisers, examining clients’ budgets, might be able to show them where they can save enough to make a meaningful contribution to the HSA.

But if they can’t find additional savings, and they are contributing to their employers’ 401(k) plans, how much of the 401(k) contributions should be diverted to the HSAs?

Financial advisers must first decide if the clients can afford to go uninsured for the amount of the annual deductible in their high-deductible plans. If so, then all their available resources can go toward their 401(k) plans, up to the contribution limit, to provide for the best possible retirement.

If, however, clients feel they need a safety net against the uncovered medical expenses and they have significant time before they expect to retire, they can take some of the money they would ordinarily contribute to the 401(k) and divert it to the HSA.

This is where financial advisers earn their keep. They must help clients decide how important the protection of an HSA account is to them, how much they will need in retirement from their 401(k) plan, how well they are progressing toward that retirement goal and therefore how much they can divert from the 401(k) toward the HSA.

Next, if the clients can afford to divert money from the 401(k), or can find additional savings to put into the HSA, the adviser can help decide an appropriate asset mix for investing the savings. Given that HSA assets can be carried forward from year to year, at what point should some of the assets be placed in longer-term investments? How much should be placed there? What longer-term investments should be used?

In all of this, the adviser and client should remember that any assets accumulated in their HSAs and not used during the working career can help to pay for medical expenses not covered by Medicare in retirement, and thus supplement the 401(k). They can also be used for regular expenses after age 65, with taxes paid in those cases, similar to other tax-deferred accounts.

The HSA issue has thrown another complication into the financial planning and investment process. As a result, financial advisers and their clients need to do more homework about HSAs and their potential role in helping clients anticipate health and retirement needs.