HSAs: The Convergence Between Health and Retirement

By Paul Fronstin, EBRI

The amount of money individuals may need to cover their health care expenses once they retire may be eye-opening for many of them. EBRI recently found that couples with long life expectancy and high prescription drug expenses could need as much as $363,000 to cover premiums and out-of-pocket expenses. Unlike in the past, the onus of saving for health care expenses in retirement has increasingly fallen on individuals as the number of employers offering retiree health benefits has dropped.

While most saving for retirement occurs in 401(k) and other defined contribution plans, in 2004, health savings accounts (HSAs) became another option for individuals. Unlike 401(k) plans, HSAs provide account owners a triple tax advantage. Contributions to an HSA reduce taxable income. Earnings on the assets in the HSA build up tax free. And distributions from the HSA for qualified expenses are not subject to taxation. Because of this triple tax preference, some individuals might find using an HSA as a savings vehicle for health care expenses in retirement more advantageous from a tax perspective than saving in a 401(k) plan or other retirement savings plan.

However, HSAs have some limitations when it comes to saving for health care expenses in retirement. First, compared with 401(k) plans, HSA contribution limits are relatively low. In 2019, workers with employee-only health coverage can contribute only $3,500, while those with family coverage can contribute $7,000. An additional annual $1,000 catch-up contribution can be made by those ages 55 and older. After 10 years, individuals can accumulate only about $68,000 if they have an annual rate of return of 7.5 percent. To the degree individuals take distributions from the HSA during their working years to pay their medical expenses because they have a high-deductible health plan, they will have that much less for health care in retirement.

According to the EBRI HSA Database, HSAs that were established in 2007 had an average balance of $8,384 at the end of 2017. Why was the average account balance so much lower than its $68,000 potential? Ninety percent of accounts established in 2007 took a distribution in 2017, only 10 percent of those accounts were investing their assets in something other than cash, and only 26 percent contributed the maximum amount allowed by law.

In the financial services marketplace, we are seeing a convergence between some of the largest HSA providers and retirement providers. In 2017, HealthEquity acquired 401(k) provider BenefitGuard, and Optum and Empower Retirement began integrating their HSA and 401(k) products. Fidelity already offers both 401(k) and HSA products. Fidelity found that individuals who contributed to both their HSA and 401(k) contributed an average of 9.9 percent, while those who contributed only to their 401(k) contributed 8.5 percent.

There is still a lot we do not know about the interaction between HSAs and 401(k) plans. How many individuals cut back on 401(k) contributions when they open an HSA? How many contribute the maximum to both accounts? And how does the presence of an HSA affect retirement income security? These are the kinds of questions we will be answering in the future as we explore the intersection between HSAs and 401(k) plans.