Health Savings Accounts Fueling Retirement Part IV: A Parallel Approach

As we have learned, HSAs can be used as retirement vehicles because they’re portable, enduring, and triple-tax advantaged. Another investment vehicle – 401(k)s – can serve as a nice comparison to see how HSAs might develop in the coming years. As Devenir[1] states, “their persistent adoption could represent the second leg of the shift to consumer directed benefits, which saw 401(k) assets balloon to where they are today.”[2] HSAs must evolve to gain wider acceptance like that enjoyed by 401(k)s and other defined contribution plans.

In contrast to 401(k) plans, HSAs providers are not subject to ERISA fiduciary standards, and the market has only recently started to get a degree of due diligence scrutiny on account fees and investment plan lineups.[3] Nevertheless, the rapid adoption of HSA plans seems to be on a similar path to 401(k)s, in terms of the number of accounts if not yet assets.[4] HSA accounts have grown dramatically since their inception in 2004 to just over 23 million as of 2018.[5] For perspective, 401(k)s had roughly 19 million accounts in their 14th year.[6] Additionally, annual HSA contribution limits are far lower than 401(k)s ($3,400 for HSAs and $18,000 for 401(k)s in 2017). These and other factors justify modest HSA balances compared to 401(k)s.

Although there are more assets in 401(k)s, they are slightly more limited as a retirement savings vehicle – while contributions are tax-deductible, distributions are required when you reach the age of 70 ½ and may be taxed as income. HSA funds are neither taxed nor penalized, as long as distributions are used for qualified medical expenses. After age 65, they can also be used for non-medical expenses without penalty though taxed as ordinary income. Withdrawals for non-qualified expenses prior to 65 incur a 20% penalty in addition to ordinary income tax.

Another useful way to compare the effectiveness of investing in an HSA and a 401(k) is to compare the tax implications on both accounts. The after-tax future value framework provided by Dr. Greg Geisler in his HSA analysis is a useful tool that can be used to evaluate long-term savings objectives.[7] Dr. Geisler states that for certain individuals, HSAs can fuel retirement better than other vehicles and for those individuals, he suggests:

first, contribute the maximum to an HSA and contribute enough to a 401(k) to get the maximum employer match; if money is still available, next, pay down high-interest-rate debts; if money is still available, next, contribute to a 529 account if it produces state income tax savings and if funding future higher education costs of a loved one is important; and, if money is still available, contribute the maximum allowed for the year to unmatched retirement accounts.[1]

Still, while they have been around for about fourteen years, many Americans still hadn’t heard of HSAs until their recent prominence with new healthcare legislation. As a result, the HSA marketplace has not yet enjoyed the economics of scale compared to the more established 401(k) and 529 plans. Nevertheless, HSAs will come to play a more important role in the larger picture of retirement needs. By combining savings from an HSA and traditional retirement vehicles, Americans will be better prepared for healthcare expenses incurred during their retirement years.

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