Clients Forced to Make Roth Catch-Up Contributions? Consider HSAs  

The average financial advisor isn’t a health insurance expert, but if there’s one tool they should understand, it’s a health savings account. 

HSAs not only boast a rare triple tax benefit, they also offer significant flexibility as a retirement planning tool, especially for the wealthy. In fact, the significant long-term tax savings HSAs can generate for higher-income earners have caught the attention of at least one progressive lawmaker, who last year proposed legislation to curtail their features. The consensus, however, is that HSAs are here to stay, so advisors should learn how to make the most of them, particularly in the context of retirement planning. 

“The current healthcare environment is wildly challenging for the typical worker and retiree, primarily due to confusion around the tools and offerings available,” said Erik Wissig, chief operating officer at health care technology provider SureCo. “That said, those who do take the time to understand and engage with their HSAs recognize a ton of power in them.” 

HSA contributions and growth go tax-free, as does spending on qualifying medical costs. The cherry on top for retirees over age 65? HSA funds can be used tax-free for Medicare Parts B, D and Advantage premiums, while non-qualified withdrawals are simply taxed as ordinary income. Those features make HSAs an attractive complement to 401(k)s and IRAs.

HSA as Retirement Account 

Wissig expects HSAs to grow in popularity, especially if more employers make contributions to employees’ accounts to help them build meaningful balances. Furthermore, the recent IRS rule change allowing Affordable Care Act bronze and catastrophic plans to be HSA-eligible is “a terrific development,” he said, allowing individuals who prefer lower-premium plans to tap HSAs.

One emerging strategy for affluent savers is directing would-be 401(k) or IRA catch-up contributions to an HSA, now that higher-income earners must steer them to Roth accounts. Under current law: 

• Savers age 50-plus whose FICA wages exceeded $150,000 in the preceding calendar year must use Roth accounts for catch-up contributions, which allow employees aged 50 and older to contribute extra money to their 401(k) plans. 
• If a 401(k) plan doesn’t offer a Roth option, high-earning participants cannot make catch-up contributions.

For late-career workers who know they are going to have substantial medical expenses in retirement, which is almost a certainty for most people, maximizing the HSA is often more mathematically beneficial than paying taxes upfront through a Roth account, or on the back end through traditional contributions. 

“That said, it shouldn’t be a total replacement,” Wissig recommended. “HSAs should be used in combination with traditional retirement accounts to create a diversified, tax-efficient drawdown strategy.”

All in the Family. In some cases, clients may elect to direct funds to another person’s HSA, usually an adult child. Current law permits children to remain on their parent’s health insurance plans until they reach age 26. If they start early and have no major health issues, an HSA that earns even modest investment returns can grow into a substantial sum. Plus, the child can claim a tax deduction for the contribution.