Where can employees save the most--tax-free--for retirement?

The retirement gap (the difference between what employees need to save and what they have saved) is growing, and COVID-19 is making it worse. And while it is clearly the responsibility of employees to plan (and save) for retirement, employers have a unique opportunity to help get them in a better position.

Employers need to focus on this issue now because 4 out of 5 employees’ personal finances are impacting their job performance. By reducing the stress created by these concerns, employers can improve employee satisfaction and retention, while increasing individual performance. This directly influences their profits and revenue. A direct focus on an employee’s personal savings might be the best way to increase overall company performance.

To top that off, employees will begin a yearly concentrated review of their personal finances and retirement contributions during open enrollment and continuing through early January. There could not be a better time to engage with employees.

Where to start

The easiest way for employers to approach retirement savings is to go with the gold-standard and the status quo – the 401(k). However, we now know that a laser-focus on that single retirement vehicle limits the savings and tax opportunities for employees.

That’s where a health savings account (HSA) comes into play. An HSA allows employees to save, spend, and invest money tax-free. Employees can also use it for qualified medical expenses today and well into retirement.

The HSA has triple-tax benefits, including tax-deductible contributions, tax-free interest, and tax-free investment growth and withdrawals for qualified medical expenses. Those funds never expire and are owned by the employee for life. After the age of 65, the money can be used for any purpose like with a 401(k), but there are no required mandatory distributions.

It might have been designed as a health savings vehicle, but an HSA is the most flexible retirement vehicle there is. You could even call it the new stealth 401(k).

“Don’t get stuck on the original purpose; an HSA can be used dynamically for both retirement and health care savings.”

It’s not often you can find flexibility in the complex regulations of the IRS, but HSAs provide that opportunity. This should not be an either-or choice. In fact, the combined impact adds more value than any singular retirement vehicle can. We will explore that more below.

Bundled savings

Thinking of employer-sponsored retirement benefits as a one-stop-shop not only diminishes the savings opportunities but completely misses the impact of bundled savings. As in 2020, 2021 401(k) contribution limits remained at $19,500. HSA contributions limits in 2021 are $3,600 for individual coverage and $7,200 for family coverage. HSAs provide a clear and direct path to additional retirement savings, with the added flexibility of qualified health care spending each year. You can review HSA-eligibility details for 2021 here.

Account holders who have both a 401(k) and HSA save more, in terms of contributions and dollar amounts, than account holders with only one. The collective impact of the bundled savings of both a 401(k) and HSA is dramatic. The combined contribution increase is 2.9%. Over a 20-year period, that results in a 42% increase in savings compared with those who just have a 401(k). In dollars, that amounts to $265,00 in projected savings vs. $187,00 in projected savings.

What this increased savings actually understates is the result of an individual’s personal finances in retirement. While the larger nest egg is significant, it undervalues the day-to-day impact. Adding an HSA with a 401(k) means that, even in retirement, account holders continue to pay for medical expenses 100% tax-free.

The result? The dollars they have go farther and their savings last longer. The combination of a 401(k) and HSA means dedicated funds for both general finances and health care costs. This eliminates the need to portion funds from your personal retirement savings to pay for the $295,000 per couple in expected out-of-pocket health care expenses on top of expected Medicare coverage. The power of these combined accounts goes above the dollar value when the tax-savings are considered. Using an HSA enables a 35% reduction in qualified health care costs (assumes combined income tax savings, state and federal of 35% or more).

Educate now

The impact here is clear. How to best communicate that to employees is the challenge. Education is at the crux of ensuring that employees understand how their savings and health care decisions today will impact their personal finance and retirement options in the next 20 years.

If your organization is in the midst of open enrollment, consider a new way to introduce benefits. Help employees understand that HSAs bridge retirement and benefits. Start with retirement benefits and a 401(k), like normal. Introduce the HSA as both a health care and retirement savings vehicle. By introducing the HSA before your health care benefits, employees can review health plan eligibility when making their benefits decisions. This sequence creates the best opportunity for employees to optimize their tax-free savings, with both a 401(k) and an HSA.

If your organization has already completed open enrollment, employees can still add an HSA, at any time, to an HSA-eligible health plan, like a high deductible health plan (HDHP). HSA enrollment is not limited to an open enrollment period.

This time of year, personal finance concerns jump to be top of mind for employees. In fact, the #1 New Year’s Resolution for nearly half of Americans is to save more money next year.

Retirement savings (or the need to save) is also top of mind for most employees but generally feels less approachable with many unsure of how or where to start. That sentiment only grows as we approach the new year. The negative financial impact of COVID has significantly raised these concerns. The retirement gap is real and growing. It might be obvious that adding a second tax-free retirement account is an easy way to increase retirement savings. But the combined impact of those two accounts — the 401(k) and HSA — increases savings for both accounts.

This information needs to be shared with employees. The result is not just increased retirement savings but also reduced financial stress. It’s your job to start this education early each year, then repeat it and reinforce it. Education unlocks the opportunity for increased retirement savings. Employers have the ability to control the impact here by driving regular education and sharing education tools. Showing the increased savings value of your employees adds a clear advantage in a competitive job market.

Shobin Uralil is the COO and Co-Founder of Lively.

Disclaimer: the content presented in this article is for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.