Health savings accounts: Transforming health care, forcing hard choices

The dilemma for advisers: Helping clients who can't afford to save for retirement and health care

Nov 30, 2014 @ 12:01 am

By Darla Mercado

It isn't every day that an adviser would recommend that a client cut back on 401(k) contributions, but financial planner Ben Wacek recently suggested that an investor do that in order to better manage the cost of health care.

The client, an engineer in his late 20s, was a model example of retirement preparedness: He was deferring 15% of his $65,000 salary into his retirement plan and his employer was boosting that with a 50% match up to 8%.

Despite the client's diligent 401(k) deferrals, he had very little saved outside the plan. Worse yet, he was in a high-deductible health care plan with zero employer contributions into a health savings account for upfront medical expenses. He has to sock away $3,000 to meet the deductible before the employer plan kicks in.

Going without savings or a balance in an HSA is akin to being uninsured, in a sense: There's no cushion to absorb the expenses up to the deductible.

“The HSA up to the deductible is insurance for the client, except that it's tax-advantaged,” Mr. Wacek said.

Enter the compromise between two goals: funding long-term retirement savings targets and short-term medical expenses as employers shift the responsibility of both tasks to workers.

More people are being enrolled in HSA-eligible plans as employers go from offering high-deductible plans as an option to making them the only health benefit available. A Towers Watson survey of 379 employee benefits professionals from midsize to large companies revealed that 17% of the plans offer an account-based health care plan as the only health benefit in 2014. That number could be 50% by 2017.

(More: Medicare: The next frontier)

High-deductible coverage and HSAs are proliferating because of the rising cost of care. Workers' contributions to the account are deductible from taxable income, and returns can accumulate on a tax-free basis inside the account. Distributions from the HSA aren't counted toward taxable income, provided the withdrawals are covering qualified medical expenses.

As HSAs transform health care, they are also revamping another key aspect of individuals' lives — retirement savings. Advisers now ask: Can HSAs work alongside 401(k)s so that they complement each other, allowing employees to save for two objectives at the same time?

SAVINGS STRUGGLE

Competition for dollars between the HSA and 401(k) “is a realistic concern for the person who wants to maximize their retirement and health care dollars,” noted Pat Jarrett, owner and chief operating officer of Health Savings Administrators, which offers a third-party investment platform for HSA plans. “Advisers are going to align the 401(k) and the investment HSA so they can make one strategy, and that will help people put the whole package together.”

Most advisers recommend that clients put enough money in their HSAs to cover the deductible, if not more. Mr. Wacek suggested that his engineer client trim contributions to the 401(k) from 15% to 8%, so he'd still be eligible for the full employer match. For an eight-month period, money that otherwise would have gone to the retirement plan will flow into the HSA until the client has $3,000 to cover medical costs. At the end of the period, they will figure out where the client stands on meeting the HSA goals, and revisit raising 401(k) deferrals.

“It's a significant reduction [in 401(k) contributions], but there's still a significant amount being saved for retirement,” Mr. Wacek said. The client “had just a small amount of savings outside of all this; if they had more money, the recommendation would've been different.”

HSAs' POTENTIAL

HSAs are only in their 10th year of existence, with modest balances on average, according to data from the Employee Benefit Research Institute. The average HSA had a balance of $1,766 at the end of 2013, up from $1,280 at the start of the year. Older users had larger accounts on average: Those over 65 had accounts with an average balance of $4,460, while those under 25 had $697 on average.

Employees are using their accounts, too. The average amount distributed for health care claims in 2013 was $1,953, according to EBRI.

For the most part, small HSA balances are conservatively allocated toward cash to ensure liquidity for near-term health expenses, according to Kevin Crain, head of institutional retirement and benefit services at Bank of America Merrill Lynch.

At BofA, investment diversification becomes more of a serious conversation once accounts hit the $10,000 mark.

$10,000 THRESHOLD

About 15% of Bank of America's HSA holders have account balances of $10,000 or more. Over that threshold, they have an array of 20 to 25 stock and bond funds to choose from. There tends to be an even split in allocation toward equity and fixed-income mutual funds, according to Mr. Crain. But he expects a greater shift toward equities as account balances grow and as participants view HSAs as a long-term pot of money.

Opportunities await advisers both on the retirement plan side and the employee benefits side as all long-term savings vehicles work in concert.

“A lot of people are looking at what's the total benefits package, and how does the retirement plan integrate with what you do on other group benefits,” said Jim O'Shaughnessy, managing principal at Sheridan Road Financial. Much of the discussion with employers on HSAs thus far has been exploratory, but he plans to approach the firm's record- keeping partners on handling HSAs.

Mr. Jarrett's company, which provides an investment platform for HSAs, is making advisers working in the employer space a focal point for next year. Health Savings Administrators plans to open the architecture of its platform so that advisers can create a customized group of funds for an HSA. The lineup can even match what's available in the 401(k).

Advisers can also cover the HSA when talking to participants. “We know that if highly compensated employees are being limited [in how much they can contribute to a retirement plan], then they should be maximizing their HSA contributions,” said Jania Stout, managing director and co-founder of Fiduciary Plan Advisors.

The relationship Ms. Stout has with health benefits experts tends to be a collaborative one, rather than a competitive one: 401(k)s are discussed alongside health care benefits. At benefits enrollment, “we put in a couple of slides that talk about looking at the HSA as an expansion of retirement savings,” she said. “The more we can merge defined-contribution health and defined-contribution retirement, then the better off we'll be when we retire.”

MAKING MOST OF AN HSA

On the wealth management front, advisers are looking at how they fit into the bigger picture of a client's finances.

For clients who are working, there's an element of budgeting as advisers reassess the ease with which they can maximize HSA and 401(k) contributions.

“I always recommend that clients contribute at least enough for the company match in the 401(k) first,” said Sophia Bera, founder of Gen Y Planning. When deciding how much to contribute to the HSA, use the previous year's medical expenses to get an idea of how much will be necessary, she said.

Don't forget the tax benefits of HSA contributions made through payroll. They aren't subject to FICA taxes, leading to a savings of about 7.65%, according to Drew Weckbach, a planner at the Commerce Trust Co.

Better yet, there are benefits for those who are able to build sizable accounts and keep them through retirement. Though retirees cannot continue adding to their HSAs once they sign up for Medicare at 65, these accounts can still be used to cover medical expenses in retirement on a tax-free basis. The balance will continue to roll over year over year, and if invested, benefit from market appreciation.

“The account is yours for the rest of your life with the HSA,” said Lazetta Braxton, founder of Financial Fountains. “Health care costs are the highest at retirement, and you can still have your money growing for you.”

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