The U.S. healthcare landscape has undergone numerous changes over the past decade. Examples include increasing life expectancies in the U.S. and meaningful growth in the number of people with access to health insurance under the Affordable Care Act to name a few. Healthcare inflation has generally outpaced inflation over this period, partly due to substantial increases in prescription drug spending, particularly among high cost specialty drugs, as well as new treatments for cancer and multiple sclerosis. According to the U.S. Office of the Actuary, healthcare inflation was approximately 3.6% in 2014, which was more than four times the pace of the Consumer Price Index but well below the long-term trend due to low interest rates and modest inflation. However, over the past fifty years healthcare inflation has averaged more than 6% annualized and has even exceeded 10% at times. The U.S. Office of the Actuary is projecting this figure will return to more normalized levels of approximately 6% over the next decade.
How does this translate into real dollars? A 2015 Fidelity report conducted by its Benefits Consulting Group estimates healthcare costs in retirement will rise from $220,000 in 2014 to $245,000 in 2015 for a 65-year old couple retiring this year, assuming average life expectancies of 85 and 87 for a male and female, respectively. The sticker shock has subsequently prompted many companies to reexamine and potentially modify the way they provide benefits to help control healthcare costs and promote a new level of engagement and informed decision-making. Some of those changes include the adoption of High-Deductible Health Plan (HDHP) and Consumer-Driven Health Plan (CDHP) options either alongside more traditional Preferred Provider Organization (PPO) and Health Maintenance Organization (HMO) offerings or as standalone options. Both HDHPs and CDHPs are paired with interest-bearing Health Savings Accounts (HSA) which are funded with pre-tax dollars and used to pay for eligible healthcare expenses today and in retirement. Individuals may also make after-tax contributions and take a deduction when they file their taxes. The underlying premise behind both high-deductible plans and HSAs is that individuals will spend their healthcare dollars more prudently if they are using their own money. Contributions not spent each year may roll over and remain invested to pay for healthcare costs incurred in the future and throughout retirement.
For 2016, the IRS limits for HSA contributions (individuals and their employer combined) are $3,350 for employee-only coverage and $6,750 for family coverage. While not legally mandated, most employers do offer a company contribution to supplement an HSA participant’s account. Individuals aged 55 year and over may contribute up to an additional $1,000 in catch-up contributions in 2016. Furthermore, participants may start, stop or change the amount of their HSA contributions anytime during the year. Unlike Flexible Spending Accounts (FSA) which forfeit any unused funds at year end (legally required under the “use it or lose it” rule), HSA dollars and investments roll over and are portable if you change jobs or retire. HSAs also continue to grow in popularity due to their triple tax advantage:
- No federal taxes and no state or local taxes (in most cases) on HSA contributions
- No taxes on HSA investment earnings (in most cases)
- Distributions for qualified healthcare expenses from the account are not subject to taxation
While no federal taxes apply to HSA contributions, investment earnings or withdrawals used for qualified healthcare expenses, state and local jurisdictions may differ.
Importantly, HSAs aren’t limited to just cash. Once HSAs reach a certain designated balance known as the investment threshold, one may typically choose to invest a portion of the HSA dollars across a number of investment options offered by the administrator of the HSA in a separate investment account. These investment platforms are typically comprised of mutual funds similar to what one would have access to in a defined contribution plan. Additionally, some HSA administrators offer open architecture with no or minimal restrictions on investment options. The opportunity to invest HSA assets over the long-term is another compelling reason that has sparked continued growth in the savings vehicle.
HSAs are relatively new to the marketplace, dating back to only 2003. According to the Employee Benefit Research Institute, the average HSA had a balance of $1,933 at the end of 2014, up from $1,408 at the beginning of the year. Account balances averaged $655 for owners under age 25 and $5,016 for owners aged 65 and older. Meanwhile, only approximately 6% of HSAs had an associated investment account. With medical care becoming increasingly more expensive, healthcare will be among the most significant expenses for individuals in retirement. Thoughtful, early planning, which could include utilizing HSAs to save for future medical expenses, may greatly reduce the potential impact on fixed budgets in retirement.
For further information and assistance, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
