A Retirement Partnership: Tying the Knot with a 401(k) and an HSA

There’s a relatively new retirement partnership that you may not know about. It’s common for employers to view health benefits and retirement benefits as separate entities. Each type of benefit offers something different to workers, and they are both governed by their own unique set of regulations. In fact, the only thing health and retirement benefits seem to have in common is their complexity.

But health care and retirement planning benefits are closer than many often think. The introduction of health savings accounts (HSAs) has created an opportunity for workers and plan sponsors to bring these two planning benefits together—a marriage that can help support the long-term security of many workers.

401(k)s: Time-Tested and Trusted

The 401(k) plan is the dominant savings vehicle that workers are using today to plan for retirement. Since their introduction around 40 years ago, 401(k)s are the go-to plans for retirement savings in businesses large and small.

You could say a 401(k) is like the person your parents would want you to marry—you can count on it to be there for you and to help you feel more secure down the road.

Of course, 401(k) plans are subject to specific rules—they must be sponsored by an employer, and workers must meet certain eligibility requirements in order to enroll. And participating in a 401(k) is a commitment for workers—to get more of out their plans, participants should contribute at least as much out of their own paychecks to maximize any company-matching contributions.

HSAs: New Kids on the Block

Created over a decade ago by the Medicare Modernization Act of 2003, HSA plans are now used by an estimated 22 million Americans. The American Bankers Association reports HSA usage is expected to grow by about 25 percent annually.

Most HSA-eligible health plans are employer-sponsored, but anyone can open one—individuals, employees and employers—as long as a worker’s current health plan meets the requirement of a high-deductible health plan: 2018 qualifications include annual deductibles of $1,350 for individual plans or $2,700 for family plans and annual out-of-pocket expenses not to exceed $6,650 for individual plans or $13,300 for family plans.

Employees can open an HSA if they are:

• Covered by a high deductible health plan
• Not covered by another health plan
• Ineligible to be claimed as a dependent on another person’s tax return
• Not entitled to Medicare benefits

Recently, the HSA contribution limits for the 2018 calendar year were adjusted for inflation. The new limits for next year are $3,450 for an individual HSA or $6,900 for a family HSA.

Depending on where account owners open their HSAs, they may not be limited to keeping it in cash. Some HSA accounts offer investment menus of mutual funds and other investments, allowing individuals to seek higher returns on their savings if they have no plans to use the money for immediate health care needs. Plus, earnings on HSA balances are tax-free because HSA withdrawals are not taxed, as long as they are used for qualifying medical expenses.

Unlike 401(k)s, where funds cannot be touched until after age 59-1/2 (at least not without early withdrawal penalties), HSAs can be used immediately for qualifying medical expenses. But HSA funds can also be held longer for future needs.

Many people confuse HSAs with flexible spending accounts (FSAs), where money has to be spent within a calendar year. HSAs don’t have the “use it or lose it” clause—workers can roll over HSA funds from year to year if they don’t have many qualifying expenses.

Two are Greater Than One

Marrying retirement and health savings benefits is a wise proposition for many reasons. Among the biggest is the escalating cost of health care, especially for older and retired American workers. A 2013 Wells Fargo Retirement Study found that 40% of middle-class Americans report their biggest financial concern in retirement is large, unexpected health care expenses.

This is when HSAs can help. Money in HSA accounts can only be withdrawn to pay for qualifying health care costs on a tax-free basis. These same funds, if withdrawn from a 401(k), would be taxed at the account owners’ current ordinary income tax rate.

There’s also a second benefit to this partnership. After age 65, withdrawals from HSAs can be used for any purpose, not limited to qualifying health care expenses. The only catch is, these withdrawals would be subject to taxation at the account owner’s current ordinary tax rate; however qualifying healthcare expenses remain tax-free. So if a retired worker enjoys a healthy lifestyle, they may be able to tap an HSA as a secondary source of retirement income.

After setting money aside for monthly expenses, making tax-preferred contributions to an HSA for health care costs and a 401(k) for retirement income can help employees plan ahead for more secure retirement. Once participants understand how health and retirement benefits can partner together, they will be better prepared for the unexpected.