Can HSAs flip the script on retirement health care expenses?

The accounts come with powerful tax advantages, but not many people use HSAs, and even fewer use them in the optimal manner.

Health care costs present a significant retirement risk for many Americans. According to a Fidelity research report, a 65-year-old couple retiring in 2019 can expect to spend roughly $285,000 in health care and other medical expenses throughout their retirement. Women are expected to have higher costs, with roughly $150,000 in average expenses compared to $135,000 for men.

When you compare the average medical expenses in retirement to what the average 65-year-old couple has saved for retirement, you realize the issue at hand. The Center for Retirement Research at Boston College estimated that in 2016, the median household approaching retirement with a 401(k) or IRA had roughly $135,000 saved. That total doesn’t count pensions, nonqualified savings or Social Security. But it still illustrates the problem: Many Americans entering retirement have less saved in their retirement accounts than they will need just for health care costs in retirement.

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One viable solution to the underfunding of retirement health care expenses? Health savings accounts. HSAs have some of the best tax benefits possible in the Internal Revenue Code; contributions to HSAs are tax-deductible, as are the matching contributions an employer makes. Any gain is tax-deferred, and if the money is withdrawn to pay for qualified health care expenditures, it comes out tax-free.

Sounds too good to be true, right? You don’t get taxed on the money going in, you don’t get taxed on the growth and you don’t get taxed on the distribution. It’s a triple threat and the best tax-advantaged savings vehicle in the tax code.

Although HSAs are such a powerful savings vehicle, very few Americans take advantage of them. According to a survey from America’s Health Insurance Plans, roughly 22 million Americans chose to use an HSA in 2017. The good news is, that’s more than a 9% increase in enrollment from 2016.

So why aren’t more people using HSAs? One factor that might hold them back is that you have to be enrolled in a qualified high-deductible health care plan to be eligible for an HSA. Many Americans aren’t enrolled in that kind of plan and therefore can’t take advantage of any HSA benefits.

But even for those who are using an HSA, it appears many aren’t optimizing their accounts. According to research by the Employee Benefit Research Institute, many Americans are using HSAs as a specialized annual checking account for health care and not as a long-term savings vehicle. Sixty-six percent of HSA users withdrew funds. And only 5% of HSA users invested in anything other than cash in 2017.

This is unfortunate, as perhaps the best benefit of an HSA is the ability to save for the future with tax-deferred and potentially tax-free investment gains. Even people who use HSAs today are essentially using them wrong and missing out on the best benefit: tax-advantaged investment growth.

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The misuse of HSAs shouldn’t come as a surprise. A new study by HealthSavings Administrators showed a general lack of knowledge around HSAs among both financial advisers and consumers. In the survey, 36% of advisers said they didn’t fully understand how HSAs work, and 40% said their clients didn’t understand HSAs.

Advisers’ lack of knowledge about HSAs proves to be bad news when a client gets one. According to the same survey, 47% of advisers position HSAs as a spending account, rather than a savings.

Even if a client were to get an adviser to help with their HSA planning, there’s a good chance the adviser would recommend using the HSA as a short-term spending account, thereby missing out on the long-term investment potential.

HSAs can be used to help pay for a plethora of expenses: retirement health care costs, Medicare premiums, long-term care premiums and other health care out-of-pocket costs in retirement. However, we need to use and fund HSAs while working — investing for the long term to maximize their tax benefits for retirement.

The script on HSAs needs to be flipped to help tackle the tremendous health care costs many Americans will face in retirement.

HSAs should be approached from a long-term investment and retirement approach, not just used as a checking account. The sooner advisers and clients embrace that mindset, the better.

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Jamie Hopkins is director of retirement research and vice president of private client services at Carson Group.