Philadelphia Reflections

Overfunding for Retirement

Independence Blue Cross (of Philadelphia) has imaginatively designed a Health Savings Account product for retirement purposes, by allowing the employer or the employee to overfund an HSA with $750 annual contributions, looking ahead to the employee's retirement. The HSA part is presented as an add-on to conventional Blue Cross, although it is unclear whether that is required. Independence Blue Cross should be given credit for a good idea. Whether it supplements health insurance before retirement, is apparently left up to the employee, but of course, it does supplement any other after-retirement arrangements the employee may have because the HSA continues on after Blue Cross itself terminates at age 66.

Since employers may soon face an un-suspended requirement to provide health insurance meeting ACA requirements, the high deductible from the government plan might simultaneously supply the high-deductible requirement for the HSA. This seems an efficient way to address present uncertainties and could provide the basis for compromise discussions between the two political parties on the whole subject of fringe benefits. High-deductible is good; adding subsidies confuses the intent. Keep them separate.

Savings unused for healthcare are available for retirement living.

Overfunding is always a good idea for subscribers to HSA, whatever their other program features. Politicians avoid overfunding anything because of voter reaction, so private plans are generally more flexible than public ones, while voters tend to complain that instead of overfunding, taxes should be reduced. The program is so new, and its time periods so distant, that unintentional gaps in coverage are always possible. If worries prove unfounded, overfunding leads to more money for retirement, hardly a tragedy.

Over-investment in Health Savings Accounts -- The Retirement Alternative. Because it's a new program, with financing uncertainties, we advise everyone with an HSA to consider overfunding it as a precaution. Just about everyone could readily use surpluses for some of his retirement. Although the employer only donates $750 per year, the law allows a total of $3350 as a maximum, and so a $2600 personal supplement is required in the following three hypothetical but typical situations. At this level, the employer contribution is a small factor; what really matters are inflation and interest return. And starting at an early age.

Example One. Let's say an employee starts the program at age 21 and remains with the company until retiring at age 66, contributing $3350 per year to the HSA (in the Blue Cross plan, $750 comes from the employer, and the employee must supplement $2600 from personal funds). (It makes no difference whether the employee rises through promotions or remains at an entry level; the maximum is the same.) Result: the employee receives a taxable retirement income at age 66 from the HSA to IRA transfer of $81,616 per year until age 83, dropping to 66,642 with 3% inflation. If the life expectancy of 93 is anticipated, the yearly annuity drops to $65,621, dropping to 48,595 with inflation..

Example Two. Another employee enrolls at age 21 but retires to get married at age 26. At age 66, until death, there is a yearly $23,423 retirement income assuming a life expectancy of 83, and dropping to 19,125 with 3% inflation. Assuming 93, the annuity is $ 18,832 with and $ 13,946 without 3% inflation.

Example Three. An employee joins the firm at age 61 and remains until age 66. His retirement income is $1,886 per year, dropping to $ 1,540 with inflation, Assuming expectancy of 93, he gets $1,516 yearly, or $1,123 after 3% inflation.

In the examples, many things jump out. The first is the large disparity between what five years of work will get you, starting at age 21, compared with the almost pitiful amount a person age 61 will get for the same absolute, and maximum allowable, contribution. The difference between examples is the difference between whole social classes. That difference, of course, is made up out of the income compounded internally for 40 years. And the moral is clear, a small steady investment at an early age is worth far more than the same investment at the end of working life. It happens to cost the employer the same, either way, and he may not realize it. His viewpoint will depend on what value he places on maturity and experience in an older employee, as compared with vigor and strength in a younger one; the pension costs would be the same.

However, this is a major change in pension design, and people should familiarize themselves with it. The employer can make far more difference in an employee's life with the selection of savings plan, than with salary. Perhaps another way of looking at it is the employee gets to keep the interest compounding in an HSA, whereas in other plans the employer gets to keep it. Or, depending on how the contract is written, some middle-man gets to keep it. The old defined benefit plans placed much more emphasis on training and experience and much less on the age and duration of enrollment. It's a new ball game. For example, there is no reason why an employer couldn't have two plans, with an optional choice, one for young people, the other for latecomers.

The second point revolves around the interest rate being paid. The investment manager, whether in-house or by way of a vendor, is able to earn and should be able to earn, 12% on an index fund of the common stock of the whole American market. Inflation at a steady rate of 3% for a century, reduces that return to 9%, net of inflation. How much is the employee entitled to?

Much depends on whether inflation is pre-deducted in advance, or calculated at some later time. If an employee is paid less than 3% per year for his HSA, he actually loses money on the exchange. If he is paid 7.5% gross, he only receives 4% net of inflation, in spite of surrendering half of the net gain (4.5% of 9%) to the broker or manager.

In this example we have arbitrarily assigned him 6.5%, which is 3.5% net of inflation, yielding well over half of the margin to the broker. I have to wonder whether the services provided are really worth more than 1% (for example, one nearby trillion dollar firm only charges a tenth as much), so it seems as though a fair return to the investor/subscriber should be 5%, net of inflation, net of fees, or 8% gross. So, be careful to identify whether inflation is anticipated, or only calculated after it happens. Sometimes, both approaches are adopted, and someone is seriously affected by not noticing it.

That means the price debate ranges between 3% (no profit to the investor at all) and 8% (essentially the wholesale price). Throughout this book, I have generally adopted 6.5% as an average, mainly to be safely conservative and avoid arguments. The marketplace will eventually settle on the "right" price, but if it's less than 3.5% net of inflation, it's less than a quarter of the wholesale price. Eventually, I expect the price to be knocked up to 8%, net of inflation, or 11% gross. The ultimate effect of this price pressure on the cost of health care would be considerable, indeed. Sustainable retirement would come into sight, and as we have mentioned, the price of healthcare is linked to it.

Now, I don't want to be accused of starting a revolution, but my calculator tells me if the passive investment could achieve 6.5% income return, the first of the three examples cited above would receive a retirement income of $81,616 per year. And the old fellow who decided to work for a few years to build up his retirement would receive $1,866. The youngster who worked for five years and then quit could look forward to a pension of $23,423 per year. Something tells me this is too destabilizing, so I'm not going to get impaled on the barricades discussing it. Ultimately, it probably reflects a reduction of transactional costs by electronics, which has not yet worked its way through to retail consumers. So, one way or another, something is going to happen, and it's up to all of us to make sure it is benevolent.

Overfunding health insurance by one means or another is a very good idea if you can afford it -- and you keep your wits about you.

Originally published: Thursday, July 16, 2015; most-recently modified: Thursday, May 02, 2019