×

Rising health costs may cause people to contribute less to 401(k) plans. Here's what can help

  • More than 60 percent of employees said they are contributing less to their 401(k) plans because of rising health costs, according to a new survey from Bank of America Merrill Lynch.
  • Health savings accounts, which offer tax advantages, can be used to pay medical expenses and other costs now and in retirement.
  • Forty-nine percent of people with a health savings account don't know that they can invest the money in their accounts, according to Fidelity Investments.

Skyrocketing health costs don't just make it harder for you now — they can diminish your retirement, too.

More than 60 percent of employees said they are contributing less to their 401(k) plans because of rising health-care costs, according to a new survey from Bank of America Merrill Lynch.

"Financial stress caused by rising health-care costs is affecting other goals people have, like retirement," said Kevin Crain, head of workplace financial solutions at Bank of America Merrill Lynch.

The survey, conducted in September and October of 1,242 workers who contribute to a 401(k) plan, also found that rising medical costs tend to hurt women more than men. (See chart below.)

Employers can do several things to blunt the pain of health-cost increases on retirement accounts, Crain said. They can automatically enroll workers in retirement plans and gradually increase their contributions, allowing employees to opt out. Companies can provide financial wellness programs to help employees make ends meet. Finally, employers can offer workers health savings accounts, or HSAs.

"It's early days for HSAs," Crain said. "And millennials really like them because they are portable and controllable."

More from Your Money Your Future:
Ditch the 4 percent rule. How to handle your retirement withdrawals
Use these homegrown tools to figure out if you could retire early
Tax reform could slash charitable giving by up to $13 billion per year

So what exactly does an HSA do? The account offers triple tax advantages. First, contributions are tax deductible. Second, those contributions can be invested and grow tax-free. Third, withdrawals aren't taxed as long as you use them for qualified medical expenses, such as doctor's visits, prescription drugs and dental care.

The downside is that you have to use an HSA with a high-deductible health plan. Such a plan means you'll have to pay a deductible of at least $1,300 for individual coverage and $2,600 for families this year. The maximum 2017 out-of-pocket costs for these plans are $6,550 for individuals and $13,100 for families.

Assets in HSAs have risen to an estimated $37 billion at the end of last year and reached $41 billion in assets during January, according to Devenir, an HSA consulting firm in Minneapolis. Devenir forecasts assets in the accounts could reach more than $53 billion by 2018, a 20 percent increase from 2017. (See chart below.)

HSAs don't seem to crowd out 401(k) contributions and may actually be increasing overall retirement savings among workers.

Employees using both a 401(k) and HSA had a higher savings rate, 10.6 percent of their 2016 salary, compared with those saving in just a 401(k), which was 8.2 percent of salary, according to a recent analysis of the employee benefit programs Fidelity manages for more than 23,000 businesses. Fidelity found that 88 percent of people who opened an HSA maintained or increased their 401(k) savings after they enrolled in an HSA.

Will Applegate, vice president of HSA business development at Fidelity, expects more employers to only offer high-deductible plans to workers in an effort to control rising health-care costs. That, in turn, will drive the growth of HSAs. "It's a minority approach among employers now, but it's a growing trend," Applegate said.

HSAs could improve

Republican lawmakers and President Donald Trump have made the expansion of HSAs a part of their plans to replace Obamacare.

The American Health Care Act, which passed the House last month, will increase the annual limit on HSA contributions to match the annual deductible and out-of-pocket expenses under a high-deductible health plan. That means the HSA contribution limit could be at least $6,550 for individuals and $13,300 for families beginning next year.

The House bill also makes HSA rules more flexible by:

  • Allowing both spouses to make catch-up contributions to one HSA beginning in 2018.
  • Permitting qualified medical expenses incurred before HSA-qualified coverage begins to be reimbursed from an HSA as long as the account is established within 60 days.
  • Letting people use their HSAs to pay for over-the-counter medications, which was restricted under the Affordable Care Act.
  • Lowering the tax penalty if you use an HSA to pay for unqualified medical expenses to 10 percent, from 20 percent. (If you're 65 or older, you can withdraw from an HSA penalty-free, but you do not get a tax break if you use the money for something other than health care.)

Roughly three-quarters of people who have HSAs withdraw less than they contribute. People who invest their HSA money in stocks and bonds have an average balance of $14,000 compared with $2,500 for those who keep it 100 percent in cash, according to recent research from Fidelity Investments based on data from the accounts it administers.

How to pick an HSA

Unlike flexible spending accounts, you don't have to "use it or lose it" with an HSA each year. In fact, more than three-quarters of HSA account holders withdraw less than they contribute, and roughly a quarter of people don't touch any money from their accounts, according to Fidelity.

Your employer may direct you to sign up with its preferred HSA provider, but if you are enrolled in a qualified high-deductible health plan, you can choose whatever provider you want. However, if employers only offer matching HSA contributions to their preferred provider, it makes sense to stick with them.

Roughly 80 percent of employers give "seed money" to workers to fund their HSAs, according to Fidelity. That can come in the form of a direct contribution or a dollar-for-dollar match. The average contribution at Fidelity-run plans was $541 last year.

If you do receive matching contributions to your HSA, Roy Ramthun, president and founder of HSA Consulting Services, recommends that you keep one HSA with your employer's preferred provider and open another one to use as an investment account.

Devenir estimates that about 4 percent of people are using their HSAs as investment plans. Many HSA providers require that you have at least $1,000 in your account before you can invest.

How should people invest their HSA money? Generally, you should have enough cash in your HSA to cover expected medical expenses and invest the rest. Here are some portfolio guidelines Fidelity uses based on age:

HSAs can travel with you if you change jobs or insurers. Use HSASearch, which is run by Devenir, to comparison shop for more than 320 providers. Just like with any retirement account, fees and investment options matter.