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Are You Part of the 12%?

“Too often, companies introduce their HSA program during open-enrollment meetings. Usually, by the time presenters review the benefits of the medical options, there’s little time to discuss the medical account. Ideally, you start your HSA education program four to six months before the start of the new medical plan year. The goal is to teach employees the power of an HSA as a financial account before they move into the open-enrollment period, which is dominated by the specific benefits of the medical, dental, and other coverage plans.”

William G. (Bill) Stuart

Director of Strategy and Compliance

July 12, 2018

You’ve heard that in any survey of intelligence or looks or personality, most of us, even those who don’t live in Lake Wobegone, think we’re above average. The truth, of course, is that statistically only half of us are right.

This concept extends to Health Savings Accounts as well. A recent survey showed that while three-quarters of employees self-identified as being knowledgeable about HSAs, only one in eight could pass a simple quiz. This dichotomy comes as no surprise to those of us who work in the HSA world, nor are most employers surprised.

Try this quick quiz that follows. The answers appear later. Don’t cheat. No one but you will see your grade.

ONE. For each $1 that you contribute to your HSA for long-term savings, how much must you reduce your contribution to your 401(k)?

  1. $1.
  2. 75 cents.
  3. 50 cents.
  4. No reduction.

TWO. You cover your family on your employer’s medical insurance. Your spouse participates in a general Health FSA through his or her employer. Are you still HSA-eligible?

  1. No.
  2. Yes, without qualification.
  3. Yes, but only if you don’t reimburse your qualified expenses from the general Health FSA.
  4. Yes, but only if you limit your reimbursement from the general Health FSA to dental and vision expenses.

THREE. Your employee is no longer HSA-eligible. What happens to her HSA balance?

  1. She can spend it on qualified and non-qualified expenses, subject to taxes and penalties.
  2. She can spend it tax-free and penalty-free on qualified expenses for the rest of her life, even if she’s no longer HSA-eligible.
  3. She must wait to become HSA-eligible again to make any withdrawals.
  4. She must liquidate the account or roll it over into a 401(k).

FOUR. Which of the following statements is true of HSA contributions?

  1. They receive the same tax treatment as Roth IRA or Roth 401(k) contributions.
  2. They receive the same tax treatment as traditional IRA or traditional 401(k) contributions.
  3. They are limited to a statutory maximum that the IRS adjusts every year.
  4. They reduce the maximum contribution that an employee can make to a traditional 401(k), but not a Roth 401(k).

FIVE. Which of the following statements is true?

  1. An employee can set up an HSA with an administrator different from the employer’s partner and compel the employer to work with this administrator.
  2. Employees can open a second HSA to double their contributions.
  3. If an employee and spouse are enrolled on a family medical plan and both are HSA-eligible, each can open an HSA and each contribute to the family maximum.
  4. Employees can invest HSA balances in a portfolio of mutual funds once they reach a certain cash threshold set by the employer or HSA administrator.

The 12% figure doesn’t surprise me. The world of consumer-directed health is confusing, with acronyms like Health FSA, HRA, and HSA. To those of us who work in employee benefits for a living, the high-level differences are obvious, though the subtle differences are often confusing. And while each helps employees manage their out-of-pocket costs, they come with different rules, different tax advantages, and often different qualified expenses.

The differences are magnified when employees want to use a medical account as a retirement account. They have the power to do so only with an HSA (though their employer can create a retirement option under an HRA). And yet many employees don’t know that their HSA can be their most valuable asset in retirement, since it enjoys tax advantages superior to a traditional 401(k) or IRA, or a Roth 401(k) or IRA.

Help Employees, Help the Business

Helping employees understand the role of an HSA in retirement planning makes good sense for you and your employees (if you’re an employer) or your clients and their employees (if you’re a benefits advisor). The employer benefits because employee contributions to an HSA aren’t subject to FICA taxes, saving the company its 7.65% tax on every dollar contributed. By contrast, the company pays its portion of FICA taxes on employees’ contributions to both a traditional 401(k) and Roth 401(k). (Do you want to revisit your answer to Question 4 above?)

Saving for retirement medical expenses through an HSA makes sense for employees as well. They pay no federal income taxes, state incomes taxes where applicable (except in Alabama, California, and New Jersey) and no FICA taxes. For an employee in the new 22% federal marginal tax rate (which starts at a taxable income of $38,701 for individuals and $77,401 for families) with a 5% state income tax and 7.65% payroll tax will pay 34.65% taxes on her contribution.

Put another way, if she puts the next $1,000 of retirement savings into her HSA, her net contribution is $1,000. She can contribute only $923.50 after FICA taxes into her traditional 401(k), and her distributions are fully taxable. She can contribute only $653.50 into her Roth 401(k), though her distributions are tax-free in retirement.

If you’re sacrificing $1,000 of current consumption to save for retirement, would you rather make a contribution of $1,000, $923.50, or $653.50? It’s a huge difference, and you do your employees a great service when you point out the differences in tax treatment to them.

Helping Employees

How can you help employees understand the role, and power, of HSAs in retirement planning? Here are several suggestions:

Begin HSA education early: Too often, companies introduce their HSA program during open-enrollment meetings. Usually, by the time presenters review the benefits of the medical options, there’s little time to discuss the medical account. Further, even with time, many employees shut down as soon as they hear “high-deductible” medical plan. (Oh, how I wish Congress had called them HSA-qualified plans or low-premium plans to erase the negative stigma.)

Ideally, you start your HSA education program four to six months before the start of the new medical plan year. Your HSA administrator should be able to provide live training, either in person or via Webinar (recorded for playback by employees who couldn’t attend the live event, want to share with a spouse, or want to review some concepts presented). Your administrator also should have a library of information (videos, infographics, written material) to support HSA education.

The goal is to teach employees the power of an HSA as a financial account before they move into the open-enrollment period, which is dominated by the specific benefits of the medical, dental, and other coverage plans.

Educate regularly: A series of 10 “Did You Know?” e-mails, sent weekly leading up to open enrollment, is a great way to maintain engagement leading up to open enrollment. Your HSA administrator can help you design this program. It consists of three or four quick paragraphs describing an attractive feature of an HSA and includes a link for more information.

Provide access to a financial planner: In survey after survey, millennial employees cite the need for more financial education. They don’t know where to turn to receive good advice on how to save for a first home, consolidate and repay student loans, improve their credit scores, begin to prepare early for retirement, and perhaps help aging parents with their finances.

One of my clients contracts with several financial planners. These planners understand the medical options (a traditional HMO and an HSA-qualified plan) and the benefits of an HSA. They meet one-on-one with faculty and staff to discuss medical-coverage options and financial planning. They don’t “push” the HSA program, but they review the advantages (and, when appropriate, the disadvantages) of enrolling in the HSA program and help employees allocate their retirement savings between a 403(b) plan and an HSA.

The financial planners are also available for consultation on other issues on campus periodically and in their offices for a reduced hourly fee. The client’s faculty and staff appreciate this service because they receive specific, relevant information about integrating the right medical coverage into their financial planning and they now have an employer-approved resource with whom to discuss other financial issues.

The cost to the employer? It’s probably covered by increased FICA tax savings as employees contribute more money to their HSA. If 100 employees choose to participate in the HSA plan and contribute an average of $2,000 each to their HSAs, the employer saves $15,300. Add that figure to a portion of the premium savings (beyond the savings that this employer channels back to employees in the form of an employer contribution equal to half the deductible) and the employer is making a positive contribution to employees’ financial lives at little or no cost.

The benefit to the employees? A study by Fidelity in 2016 shows that employees who participate in both a 401(k) plan and an HSA defer 10.6% of their salary into the two accounts combined, whereas those enrolled in a 401(k) plan only defer only 8.2% of salary. For an employee earning $60,000 per year, the 2.4% difference is $1,440 in Year One. If that employee earns a 6% return on that amount and maintains the 2.4% additional savings as her salary rises 3% annually for 30 years, she has an additional $215,000 in what we hope is her HSA (rather than her 401(k) plan through which all withdrawals are included in taxable income).

The Value of the Absence of Tax Friction

How valuable is that balance in her HSA? If she retires to a state with no income tax and pays medical expenses from her 401(k) plan, she needs to withdraw nearly $276,000 to achieve the same buying power as $215,000 in her HSA. If her retirement state levies a 5% state income tax as well, she needs nearly $295,000 in her 401(k) to reimburse $215,000 of qualified expenses. That’s the power of the average additional savings and placement in the right account.

And that, in a nutshell, is the advantage of saving for retirement in an HSA. It’s simply the most tax-efficient means of saving for future qualified medical and health-related expenses.

Quiz Answers

ONE. (4) HSA contributions are independent of contributions to qualified retirement accounts. Employees can contribute to each account up to the maximum allowed by law.

TWO. (1) You’re automatically enrolled in a spouse’s Health FSA (unless the sponsoring employer excludes all participants’ spouses, which almost never happens). A general Health FSA is disqualifying coverage.

THREE. (2) HSA owners don’t have to be eligible to make additional contributions to spend their balances tax-free on qualified expenses. This feature makes an HSA an ideal account to accumulate balances to pay medical expenses in retirement.

FOUR. (3) You may have answered “2.” Your 401(k) contributions aren’t subject to federal or state income taxes, but they are subject to FICA taxes. HSA contributions are free of FICA taxes, as well as federal and state income taxes (except for state income taxes in Alabama, California, and New Jersey).

FIVE. (4) The leading HSA administrators offer accounts that have an FDIC-insured cash component and also offer mutual-fund options to build balances as the market grows (subject to investment risk).

What We’re Reading

Democrats are embracing the Affordable Care Act during the 2018 election cycle. So far, Democrats and independent groups have spent slightly more on pro-ACA ads than Republicans and independent groups have spent on anti-ACA ads. This is the first time since passage of the law in 2010 that Democrats have gone on the offensive and embraced the law more than Republicans have gone on the offensive to criticize it.

The motivation is obvious. A year and a half after the 115th Congress was seated and President Trump took office, Republicans have failed in their attempts to amend the law. Democrats have played up the aspects of the law that voters most value, covering adult children to age 26, guaranteed issue, no pre-existing condition exclusions, and narrow premium bands, to defend the law. And the public for the first time is telling pollsters that the ACA has a more positive than negative impact.

Too many critics simply don’t understand the value of an HSA. The author of this article is  no exception. He paints a picture of HSAs as accounts that benefit only higher-income individuals with high savings rates, since most Americans don’t have an additional $1,000 or more lying around to meet an unexpected medical expense. What these critics can’t grasp is that HSAs don’t create this financial problem. Rather, they help owners manage their out-of-pocket costs by allowing them to reimburse providers with after-tax dollars. So, paying a $1,000 bill costs the owner a net of $700 to $800, with the rest “paid” with tax savings. These critics need to understand that the underlying high-deductible medical coverage creates the financial liability. And most high-deductible coverage is not HSA-qualified.



One thought on “Are You Part of the 12%?”

  1. greta cocco says:

    Bill, I so LOVE reading your posts !!! In this day & age whereby EE’s are continuing to work beyond the traditional “Age 65” most are looking for the best way to maximize their ER pre-tax retirement saving opportunities which does include their HSA accounts.
    There is so much confusion swirling about especially w/respect to the “Boomers” who are aging out & the intersect w/regards to Medicare & Social Security.
    It is quite maddening for our collective clients who are simply trying to ingest a very complicated arena and thus we are so appreciative of you expert advice.
    Thank you so much for you do: as it serves us all of us better than well…….

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