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For Certain Clients, HSAs May Be a Godsend

By Chris Latham August 11, 2014

Most clients would be skeptical if you told them about a vehicle that straddles the realms of investing, tax management and health insurance — and can help with retirement planning, too. That’s one reason advisors rarely initiate conversations about health savings accounts. But as employers shift a greater share of medical costs to employees and Obamacare continues to evolve, now’s the time to start bringing HSAs into the conversation, experts say.

Matt Jehn, who runs Royal Oak Financial Group in Columbus, Ohio, says they come up at least once a week with his clients. “The topic is very relevant for folks wanting to retire pre-65, so they can use the funds for medical coverage in a tax-advantaged way prior to getting on Medicare,” says Jehn, who receives monthly retainers and commissions as well as a percentage of assets.

Introduced by Congress in 2003, HSAs are trusts or custodial accounts established to pay for qualified expenses, available only to individuals with high-deductible medical plans. Contributions and distributions are tax-exempt, according to an IRS publication that details a maze of rules.

Once the account holder reaches age 65, distributions for non-medical purposes are allowed. Before that age, income taxes and an additional 20% penalty tax may apply. Clients under 55 with individual high-deductible health insurance coverage may contribute up to $3,300 annually; those with family plans may contribute up to $6,550. At age 55, the ceilings rise by $1,000. Someone contributing the maximum for 30 years could accumulate more than $200,000. Medicare participants can’t make contributions.

HSAs come in many varieties. Some are basically interest-bearing checking accounts. Others allow account holders to invest in dozens of mutual funds and ETFs. Still others offer both options. Providers include employers, banks, insurers and specialist vendors; as with 401(k) plans, companies can choose to match contributions. As of year-end 2013, over 2,200 financial institutions offered HSAs, according to a report by Devenir, a Minneapolis-based hybrid advisory firm that specializes in health care accounts. There were 10.7 million accounts holding $19.3 billion in assets, up by 30% and 25%, respectively, since year-end 2012.

In July, Jehn advised a healthy couple on how to maximize the benefit of the wife’s HSA. They had $1 million across their retirement accounts and worked for the same company. They both plan to retire in three years, when the husband turns 65 and the wife turns 59. He then will get Medicare, but she will have to fund her medical insurance. The couple is maxing out HSA contributions over the next three years, and HSA distributions will cover her premiums until she turns 65 and can enroll in Medicare, according to Jehn.

Big Savers

When clients already are maxing out contributions to their 401(k)s and IRAs, using an HSA for additional retirement savings can be worthwhile, according to Robert Schmansky. He runs Clear Financial Advisors in Bloomfield Hills, Mich., which charges hourly and project-based fees.

For example, a few years ago he explained to a wealthy couple that if they fully funded the wife’s HSA and invested the account in mutual funds, they could maximize potential gains. This was attractive for several reasons. The wife, who was 56, planned to retire early from her high-earning job. The husband, who had been laid off, had received a generous severance package and didn’t plan to return to work. They plan to take HSA distributions after she turns 65.

“They’re in a higher tax bracket now than they will be in retirement, so pretax contributions are the perfect tool,” Schmansky says.

Joshua Mungavin

Yet advisors should beware of complications in discussing HSAs with clients, warns Joshua Mungavin, a planner with Evensky & Katz Wealth Management. The Coral Gables, Fla., firm manages over $1.5 billion. Since most advisors aren’t licensed for insurance, they can’t tell clients to choose high-deductible medical plans just to gain access to HSAs. And the vehicles have so many tax restrictions, which can change with the political wind, that staying on top of them is daunting.

Advisors may hesitate to suggest HSAs if they think other financial vehicles will yield better returns for clients, says Paul Fronstin of the Employee Benefit Research Institute. He’s director of health research and education at the Washington, D.C., nonprofit. He adds that clients with limited resources who use HSAs to save for retirement may wind up strapped for cash to cover out-of-pocket medical expenses.

Even so, Mungavin finds some HSAs offer more and better investment options than IRAs and 401(k)s. He himself has an ETF-fueled HSA and encourages advisors to walk clients through the accounts’ features — that is, “unless they have a very short time frame to save in it.” It doesn’t make sense for clients to open an HSA a year before enrolling in Medicare. After all, $4,300 doesn’t go far.