Morningstar - Q4 2020 - 32

EXPENSES

AGE 65

AGE 65

Spotlight: World After COVID-19

Withdrawal
Not Taxed

Withdrawal Withdrawal
Taxed
Taxed

Withdrawal
Taxed

Withdrawal
Not Taxed

EXHIBIT 2

wishes. That enables the funds to grow on a
tax-sheltered basis and stretches out the
long-term tax benefits. In a worst-case scenario in
which the client "oversaves" in the HSA, he or she
can withdraw the funds after age 65 and use
them for any purpose; any amounts not used for
qualified healthcare expenditures would be
subject to ordinary income tax. In that case, the
HSA functions much like a traditional IRA from a
tax standpoint. The HSA carries no income
limits, either, which makes it an excellent ancillary
retirement savings vehicle for high-income
investors. (Note that investors cannot make
additional HSA contributions once they're covered
by Medicare; they must be covered by a highdeductible plan.)
Health savings assets can also be used to cover
long-term care premiums, up to the IRS'
annual limits, which are based on age. In addition,
investors who are using an HSA as a long-term
savings vehicle and paying out of pocket for
healthcare expenses should be aware that
the HSA can function as an ancillary emergency
fund. That's because HSA assets can be
withdrawn on a tax-free basis for nonhealthcare
expenses, provided the investor has receipts to
substantiate healthcare expenses that were
previously incurred and paid with non-HSA assets.4
While high-deductible plans offered through
employers are typically paired with an HSA,
it's important to note that the insured isn't wedded
to that HSA. It's usually most expedient-
and tax-efficient-to make contributions through
payroll deductions to the HSA linked to the
high-deductible plan. However, the participant can
periodically transfer funds from the HSA to
another HSA of his or her choice.
Morningstar began rating the largest HSAs several
years ago. As of the most recent Health Savings
Account landscape report, Fidelity's HSA was the
most highly rated regardless of whether the
investor was using it as a short-term or long-term

4
5
6
7
8

Spending Smile According to Morningstar research, retirees spend the most
$12,508 the latter of which is driven
$12,508by high
$16,036
$12,508
at the
beginning$9,301
and end of
their retirement,
healthcare costs.
Initial Retirement Spending Goals
$25,000

$50,000

Real Spending Level
$1.20

$100,000

1.03
1.00
0.88
0.80
0.75
0.60
65
Age

70

75

80

85

90

95

100

Source: Morningstar.

Avg. Actual Retirement Age Among Retirees
Avg. Expected Age Among Nonretirees
savings vehicle.5 Advisors can assist clients not
68
only in choosing the best HSA but also helping
them invest the HSA assets in a sensible way given
the client's usage. A client using the HSA to
66
cover healthcare outlays as they're incurred, for
65
example, should stick with conservative
64
options like the savings account, whereas clients
employing HSAs in a long-term context can
On average, people retire
reasonably
an equity-heavy HSA portfolio. 62
about fourtarget
years early.
61
Finally, healthcare spending in retirement remains
an important consideration, and the fact that 60
out-of-pocket spending typically trends up later in
58
life is a valuable argument
2011 for amassing
2002
2019 HSA
assets. Morningstar research indicates that
spending typically trends up later in retirement,
after initially being high early in retirement
and tapering off in the middle.6 David Blanchett,
head of retirement research for Morningstar
Investment Management, calls this pattern the
"retirement spending smile" ( EXHIB IT 2 ). While
early retirement spending is often driven by

Earlier
On Track
Later
% of Total
discretionary expenditures-travel and assisting
60
adult children, for example-Blanchett's
48as
research points to higher healthcare outlays
a major driver of higher spending for older
46
retirees. That spending encompasses uninsured
long-term care expenses as well as prescription 40
drug costs andNearly
other half
expenditures.
retire earlier
than expected.

But how much can retirees expect to spend?
Research conducted by Fidelity puts the lifetime 20
in-retirement cost of healthcare for a 65-yearold couple at nearly $300,000, a figure that 6doesn't
include long-term care.7 Yet Vanguard research,
0
conducted in conjunction
1991
2006 with Mercer,
2020points
to significant variability in healthcare outlays
in retirement. Healthy people with supplemental
policies incur out-of-pocket healthcare costs in
the realm of $3,000 per year, on average, whereas
less-healthy people without supplemental
policies could easily pay more than double that
amount.8 Income level, which in turn determines
whether a retiree pays an extra premium for

See my articles "Can Health Savings Accounts Be a Bulwark Against Long-Term Care Costs?" and "3 Tricks for Getting the Most Out of Your HSA" on Morningstar.com for more on HSAs.
Acheson, L. 2020. "2020 Health Savings Account Landscape Report." Morningstar, October.
Blanchett, D. 2013. "Estimating the True Cost of Retirement." Working Paper, Nov. 5.
Fidelity Viewpoints. 2020. "How to Plan for Rising Health Care Costs." Aug. 3.
Vanguard Research. 2018. "Planning for Health Care Costs in Retirement." June.

32

Morningstar Q4 2020


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Morningstar - Q4 2020

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Contents
Morningstar - Q4 2020 - CT1
Morningstar - Q4 2020 - CT2
Morningstar - Q4 2020 - Cover1
Morningstar - Q4 2020 - Cover2
Morningstar - Q4 2020 - 1
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Morningstar - Q4 2020 - Contents
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