HSAs: the other retirement account

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A recent Wells Fargo whitepaper, “Reimagining Retirement: Generational Strategies for 21st Century Challenges,” surveyed baby boomers, Generation Xers and millennials to uncover each generation’s thoughts and expectations about retirement.

One of the whitepaper’s findings was that baby boomers expect Social Security to be their primary source for paying for retirement expenses, while Generation Xers and millennials foresee being more reliant on 401(k)s and IRAs. However, the whitepaper also found that 20% of baby boomers and Generations Xers and 30% of millennials listed “Other” as a primary source for covering retirement costs.

While the whitepaper did not provide details about what this “Other” category might be, we at HealthSavings have our fingers crossed that those respondents are using investment-focused HSAs to grow funds for retirement. Although they’re often viewed as a way to reduce taxes on current healthcare costs, HSAs offer unparalleled tax advantages on retirement medical expenses and are the single best way to save for retirement, period.

Not just for medical expenses

One reason HSAs get pigeonholed as medical-only accounts is their name: health savings accounts. Instead of thinking of HSAs as primarily for healthcare, it can be helpful to view them as IRAs with a tax-free medical bonus.

Like IRAs, HSA contributions are tax-free at the federal and state level (in almost every state), and earnings and interest grow tax-free. What’s more, HSA withdrawals for qualified medical expenses are always tax-free too; this triple tax advantage is something other retirement plans simply can’t match.

In addition, once HSA account holders reach age 65, they can use HSA dollars on nonmedical expenses and pay only income taxes on those funds, just like an IRA or 401(k). This means account holders never have to worry about overfunding their HSAs; any funds that aren’t needed for healthcare costs in retirement can be used for general retirement expenses.

Also, HSAs don’t have required minimum distributions, so the funds can continue to grow until account holders need to use them. And if an HSA account holder lists a spouse as the beneficiary, the HSA becomes the spouse’s after the account holder’s death and retains all of its tax benefits.

Bonus FICA savings

Many people understand the benefit of withholding a portion of their paycheck to their 401(k)s and avoiding paying federal and state taxes on those contributions. However, HSAs offer additional FICA tax savings that can’t be accessed with any other retirement savings account.
The FICA tax consists of Social Security and Medicare taxes, and this combined tax is typically 15.3% (the Social Security tax is 12.4% on all wages up to $132,900, and the Medicare tax is 2.9% on all wages). Employers and employees split the tax, so each typically pays 7.65%.

Contributions to a 401(k) or an IRA are always subject to FICA taxes, regardless of whether those contributions were to a traditional plan or a Roth plan. By contrast, HSA account holders never have to pay FICA taxes on contributions done via pretax payroll withholding through their employer’s Section 125 plan, and neither does their employer. That’s an extra 7.65% back to both the account holder and the employer.

Let’s break that down. If you contributed $500 each month to a 401(k), you’d have $6,000 in the account by the end of the year. If you contributed $500 each month to an HSA via Section 125 plan payroll withholding, you’d have the same $6,000 in your account at year’s end. However, since you didn’t pay FICA taxes on the HSA contributions, you’d have an extra $460 in take-home pay by the end of the year. You can then contribute that extra $460 of annual FICA savings back into your HSA. Assuming a 6% market rate, over 40 years those FICA savings alone could grow to over $75,000.

Prioritizing Your Retirement Savings

Knowing HSAs’ superior tax benefits, you may want to consider structuring your retirement contributions to increase your tax savings:

1. Contribute enough to your HSA and 401(k) to get any employer matches. Always take advantage of any match your employer offers; there’s no easier way to get free money.
2. Max out your HSA via payroll withholding. In 2019, the HSA contribution limits are $3,500 for individuals under self-only insurance coverage and $7,000 for individuals under family coverage. By contributing via payroll withholding, you’re saving FICA taxes and putting money back into every paycheck. In fact, you could even calculate how much you’re getting back in FICA savings and put that extra money back into your HSA.
3. If you have money remaining after maxing out your HSA, put it in your 401(k) or IRA. Although your contributions will be subject to FICA taxes, you’re still getting significant tax savings.

We recommend consulting with a financial professional before implementing any changes to your retirement contribution plan.

This savings strategy requires reframing the HSA as general retirement vehicle rather than as a medical-only savings account. It means changing the H in HSA to mean “holistic,” not “health,” and thinking of it alongside a 401(k) and IRA. And, it means committing to keep HSA contributions invested for the future rather than pulling them out for current medical costs.

This mindset shift may not always be easy, but it’s worth it. In the retirement planning arena, every dollar matters, and HSAs are, hands down, the best way to keep money out of Uncle Sam’s pocket and growing for the future.

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