Don’t let your clients bank on Medicare in retirement

There was a time when many American workers could anticipate sailing into retirement with profit sharing and investments, pension, Social Security benefits, and Medicare coverage. They felt secure that their golden years would be filled with rest, peace of mind, and few worries about medical bills.

Times have changed. Today, only 15% of private-sector American workers have access to a pension plan. Barely one-fifth of U.S. firms offer a profit-sharing plan. Over the first four months of 2022, the Dow lost more than 10% of its value. The average 401(k) balance for 64-year-olds is $232,000, with the median balance now less than $85,000.

Financial advisors have long recommended diversification in retirement portfolios. With retirement assistance both less available and less reliable than before, it’s never been more critical to have multiple resources on hand to help assure a successful retirement.

Even Medicare is no longer a cure-all for retirement healthcare needs. Fidelity predicts that an average 65-year-old couple will need about $300,000 in after-tax savings to handle health care costs in retirement – and that assumes they aren’t battling any chronic illnesses.

Pension plans are going … going … gone

American Express began the first U.S. corporate pension plan in 1875. After 20 years of service or reaching the age of 60, workers were guaranteed half of their yearly salary in retirement. Pension plans spread throughout corporate America, and by 1960, half of the private-sector workforce could expect to receive one.

However, by the early 1980s, employer-funded, defined-benefits pension plans began giving way to defined-contribution programs chiefly financed (if not entirely) by employees. Between 1986 and 2016, the number of defined-benefit pension plans dropped by 73%.

Social Security and Medicare are in danger

Trustees of the Social Security Administration’s Old-Age and Survivors Insurance (OASI) Trust Fund estimated in 2021 that, under current law and their intermediate assumptions, the funds used to pay Social Security old age and survivor benefits will become depleted in 2033, and those used to pay disability benefits will run out in 2057. After that point, benefits payments may continue but at only 78% of the scheduled amounts.

Medicare was enacted in 1965 to provide seniors with health insurance. However, unless Congress raises taxes or cuts benefits, Forbes estimates that the main Medicare trust fund will be empty by 2026. As with Social Security, benefits payments are expected to continue, but at no more than 91% of scheduled amounts.

HSAs help pick up the slack

Health Savings Accounts (HSAs) can help pay for healthcare expenses now and both healthcare and other expenses in retirement. Their “triple-tax savings,” among other advantages, make them a very attractive alternative to other investment vehicles.

To open an HSA and make contributions, you must be enrolled in a qualified high deductible health plan (HDHP). For 2023, HSA-qualified HDHPs have minimum deductibles of $1,500/$3,000 for individual/family coverage and out-of-pocket maximums of $7,500/$15,000.

Triple-tax advantage: Account owners can make pre-tax contributions (2023 limits are $3,850 individual / $7,750 family) that earn tax-free interest and tax-free investment gains. Funds withdrawn to pay qualified medical expenses remain tax-free, too.

Capital growth:  Unused HSA balances can be invested to grow substantially through tax-free gains and dividends.

Portability and rollover: Unlike other tax-advantaged benefit accounts, HSAs belong solely to the account owner regardless of who contributed toward the balance and where (or if) the account holder is employed. Also, funds do not go away if unspent by a specific deadline. The balance rolls over year after year.

Funds remain tax-free and available: If the account owner is no longer enrolled in a qualified HDHP, they can no longer actively contribute to their HSA account but can hold, invest, or spend the balance the same as always.

Contributions: Anyone can contribute to the account (self, employer, family members, etc.) up to the annual IRS-mandated limit ($3,850 individual / $7,750 family for 2023). Those over age 55 can contribute an additional $1,000 above the limit.

Extended contribution period:  Contributions against the annual limit can be made from January 1 of the tax year through April 15 of the following year (the tax year’s income tax filing deadline).

Tax dependents: HSA funds used to pay for qualified healthcare expenses of the account owner’s tax dependents also remain tax-free.

No penalties after 65: HSA funds withdrawn before the age of 65 for any purpose other than paying qualified healthcare expenses are subject to a 20% tax penalty in addition to regular income tax. After age 65, funds spent on healthcare remain tax-free, while funds spent on anything else incur no penalty and are taxed at the account owner’s then-current rate.

Inheritance: The surviving spouse of an HSA account owner can use any remaining account balance with all the same benefits. Once the surviving spouse passes, the next beneficiary is taxed only on any remaining balance once all outstanding medical bills for the deceased have been settled.

Takeaways

The days of guaranteed financial assistance with retirement are over, with employers no longer offering defined-benefit pensions or widespread profit-sharing plans. Meanwhile, the cost of retirement steadily increases, particularly in paying for healthcare needs as we age.

Government programs intended to help cover retiree income and healthcare needs face funding shortfalls that are likely to begin curtailing benefit payouts in the near term.

Medicare also faces funding difficulties, and even when funded, does not cover the entirety of enrollee healthcare expenses. Seniors are responsible for maximum annual out-of-pocket amounts, and essentials like dental, vision, and hearing care may not be covered at all, depending on the enrolled plan.

To help protect your clients’ income and assets both now and in retirement, HSA accounts provide tax-free contributions, and investment gains similar to a 401(k) plan, with the added benefit of tax-free spending on healthcare expenses.

Rather than banking on Medicare and other assistance programs, your clients can invest in themselves by opening an HSA account now. No age is too soon; benefits begin immediately and continue into retirement.

Candy Darr is a 15-year veteran of the employee benefits industry and is a former national conference chairperson for the Employers Council on Flexible Compensation. As DataPath’s Senior Manager of Content and Partner Marketing, Candy develops educational programming and delivers creative solutions for customers and DataPath as a whole.