The 15 participants of the first-ever IRONMAN triathlon in Waikiki, Hawaii, in 1978 each received three sheets of paper with a few rules and a course description. The last page read: “Swim 2.4 miles! Bike 112 miles! Run 26.2 miles! Brag for the rest of your life!” It is safe to assume that those who finished that first IRONMAN – and thus could brag for the rest of their lives – weren’t just in good physical condition, but were highly trained and proficient in each leg of the race. No matter how great one’s physical condition, is one will not successfully complete a triathlon if s/he are unable to swim.
When it comes to preparing for a successful retirement, financial professionals advise clients to save as much as they can. That is excellent advice. There is no question that most people need to save more for retirement. But like preparing for a triathlon, one must also be strategic and intentional in how s/he prepares for retirement. It isn’t enough to just save more. One must be strategic and efficient to be financially successful in retirement.
Expenditures in retirement can be broken down to three categories: essentials (food, shelter, etc.), lifestyle (vacations, entertainment), and health care. Per Fidelity’s most recent “Retiree Health Care Cost Estimate,” a 65-year-old couple retiring in 2016 will need an estimated $260,000 to cover health care costs during their retirement. A retiree’s ability to pay for these health care costs will obviously have a major impact on the quality of he/she retirement. Therefore, instead of taking a “save as much as you can approach”, one must be intentional and adhere to a strategic plan to prepare to pay health care costs in retirement.
The triple-tax free health savings account (HSA) offers the most powerful and efficient way for one to save for health care costs in retirement. Contributions to an HSA are tax-free, grow tax-free, and withdrawals for qualified medical expenses are also tax-free. In addition, contributions made via a Section 125 Cafeteria Plan allow an employee and the employer to avoid payroll taxes, which at a minimum saves the individual 7.65%.
An HSA is a tax-exempt custodial account that provides individuals who have a High Deductible Health Plan (HDHP) the ability to pay current and future qualified medical expenses with pretax dollars. Unlike a Flexible Saving Account (FSA) or Health Reimbursement Arrangement (HRA), an HSA is the property of the individual, unspent funds roll over year after year, and the account is portable. Unlike a 401(k), HSAs do not have required minimum distributions that begin at 70.5 years of age.
Using Fidelity’s estimate that a 65-year-old couple retiring in 2016 will need $260,000 to cover health care costs during their retirement, let’s compare one who simply saves as much as possible for retirement versus one who saves intentionally using an HSA. Assuming a 33% tax bracket, one would save slightly more than $61,000 by taking advantage of the tax advantages of the HSA rather than saving only via a 401(k). Additional savings would be realized if the HSA contributions were made via a 125 Cafeteria Plan and if one considers savings from state income taxes. Only three states (New Jersey, Alabama, and California) tax HSA contributions.
In addition to providing tax savings as one cumulates funds for retirement, using funds from an HSA versus a 401(k) to pay qualified medical expenses during retirement can result in one avoiding higher Medicare premiums. Funds taken from a 401(k) are counted towards one’s modified adjusted gross income (MAGI), while HSA funds are not included in MAGI. Medicare premiums are calculated by the Social Security Administration based upon one’s MAGI from the most recent filed tax return.
The advantage of utilizing an HSA to pay current medical expenses on a tax-free basis is evident and has been the focus of financial professionals and HSA owners since its establishment. Fortunately, financial professionals and employers are now taking a broader look at the HSA and are beginning to see it as the powerful, long-term retirement vehicle that it is.
Matt Clarkin is President of Access Point HSA, LLC.
He can be reached at firstname.lastname@example.org or 401-952-9065.