At an orientation session for my first real job out of college, many (many) years ago, an HR manager explained to our new hire class the benefit of investing in the company 401(k) plan. For a 20-something living paycheck to paycheck, seeing any dollar amount, no matter how small, disappear into an investment vehicle instead of finding its way safely into my checking account was a tough pill to swallow. But upon seeing examples of how a relatively small investment now could translate into pretty hefty future savings, and the difference that even a few years’ head start can make when accounting for investment returns and the effect of compounding interest, I was sold. I’ve been steadily (if sometimes reluctantly) maxing out my 401(k) ever since. And, a few years after my first encounter with serious “grown-up” retirement planning, I encountered another equally valuable, yet frequently overlooked, retirement savings tool: the Health Savings Account (HSA).
HSAs are a hybrid health-wealth benefit of sorts, with the potential to play an important role in both the retirement and financial plan, as well as the healthcare benefits plan. On the financial side, HSAs function much like 401(k)s or IRAs, in that they allow employees and/or employers to contribute to individual savings accounts, pre-tax, and realize tax-free investment returns on those contributions. On the healthcare side, HSAs are similar to flexible spending accounts (FSAs), in that funds can be withdrawn, tax and penalty-free, to pay for routine healthcare expenses. Because HSAs must be used in conjunction with a qualified high-deductible health plan (HDHP), the ability to easily access funds from the account to offset the higher deductible obligation is an important safety net for those concerned about the increased out-of-pocket risk compared to a regular PPO-style plan.
But a key advantage of HSAs relative to FSAs (and what makes an HSA more comparable to an IRA) is that funds contributed to an HSA carry over year to year, and can accrue over time to create a valuable source of future retirement income for the HSA account holder. FSAs, in contrast, are designed as a short-term benefit to cover the duration of the health plan year, and operate under a “use it or lose it” provision, where any contributions not used within that timeframe are forfeited. It should be noted that recent changes to FSA provisions have mitigated the “use it or lose it” risk (namely, the rollover provision that allows for up to $500 to be carried over into the next plan year), but even with these enhancements, FSAs are not built to deliver the long-term savings opportunity that an HSA offers.
First and foremost, it’s important to avoid writing off HSAs as a tax shelter for high-income employees. If we looked at 401(k)s, IRAs, and 529 plans the same way, millions of Americans would be losing out on valuable savings opportunities that can create, over the years, a very cushy nest egg for retirement (or education). Furthermore, many employers contribute to employee HSAs to help jumpstart the account balance and provide immediate relief for the higher deductible, making it even easier to justify the leap to an HDHP/HSA combo.
With that said, decisions around the best benefits option will certainly vary based upon the unique needs of an employee and their family. Many colleagues and clients I have worked with over the years were fully appreciative of the retirement savings opportunity offered up by the HSA, but were willing to sacrifice that benefit for the predictability of a lower deductible plan. Others had personal health situations where the cost of their regular medical expenses outweighed the immediate and long-term savings benefit tied to an HSA/HDHP.
Just as the best benefits decision will vary depending on an individual’s particular situation, so too will any investment decisions associated with an HSA. This includes decisions around how to invest HSA funds (those with a higher probability of near-term medical expenses may want to invest more conservatively, for example, whereas younger HSA account holders with limited health risk may opt for more aggressive investment options), as well as decisions on how to allocate and prioritize investments in an HSA relative to an individual’s other investment vehicles. I personally believe, for instance, that there’s a strong argument to be made for maxing out an HSA before maxing out a 401(k) beyond the employer match. That’s because an unexpected medical hardship is one of the biggest if not the biggest potential financial pitfalls for individuals of all ages, income levels, and health profiles - and HSAs are a much better safety net compared to other investment vehicles in that respect. It’s true that Individuals can withdraw funds from a 401(k) without penalty, in some cases, in the event of medical hardship, but the requirements and process can be burdensome and the individual will still pay taxes on the amount withdrawn. Compare that to an HSA, where funds can be quickly and easily withdrawn for any qualified medical expense penalty and tax free. If one should happen to find themselves in the unfortunate situation of having a large, unexpected medical expense to cover, being able to pull from an HSA before tapping into other investments is clearly an advantage.
Identifying the ideal solution for financial and healthcare benefits is best accomplished with the support and expert guidance of a financial or benefits advisor. And, recently, we are starting to witness financial and benefits consultants coming together to leverage their respective subject matter expertise toward the delivery of a more holistic strategy for employers and their employees. It’s an intersection of two worlds that will, hopefully, address many of the challenges that Americans face when it comes to the uncertainties of both short and long-term financial needs.