IRA and other retirement planning advisors have long anticipated the release of the final DOL fiduciary rule (the proposed version of which was issued more than a year ago). For advisors who give advice pertaining to health savings accounts (HSAs), however, the application of the rule may come as a surprise. Pulling both IRA and HSA advisors under the fiduciary rule umbrella is a reminder of the similarities between these types of accounts—and the DOL’s acknowledgement of an important alternative use for HSAs in retirement income planning.
It’s now important that HSA advisors understand the compliance requirements that will apply under the fiduciary standard—providing an opportunity for education in the alternative use of HSAs as retirement income vehicles.
HSAs and the Final Fiduciary Rule
In the final version of the fiduciary rule, the DOL acknowledges the similarities between IRAs and HSAs, including their tax-preferred treatment, and has expressed a view that HSA account owners are entitled to the same protections afforded IRA owners.
In particular, similarly to IRAs, HSAs may contain associated investment accounts that can be used as long-term savings vehicles. Further, HSAs are often invested in investments that are approved for use in conjunction with IRAs (such as annuities, stocks and bonds). HSA trusts (or custodial agreements) may also restrict investments to certain permissible investments (such as a particular investment fund).
Like an IRA advisor, an HSA advisor will generally become subject to the fiduciary standard if he or she makes a recommendation about the advisability of holding, acquiring, disposing or exchanging an investment, or makes a recommendation as to investment management of plan assets. The definition of “recommendation” becomes important in this context, and essentially means a communication that, based on its content, context and presentation, is reasonably viewed as a suggestion that the client engage in (or refrain from) taking a particular course of action.
Whether certain advice constitutes a recommendation will require an objective, rather than subjective, inquiry.
The best interests contract exemption will also apply to allow HSA advisors to continue to receive compensation when potential conflicts of interest are disclosed to the client and a contract is executed that commits the advisor to act in the client’s best interests (among other requirements).
While HSAs will be covered by the new rules, certain related products, such as health, disability and term life insurance policies, are expressly excluded from the definition of investment property and are thus not subject to the fiduciary standard.
The Retirement Income HSA
The similarities between IRAs and HSAs have led to the development of an important alternative use for HSAs in retirement income planning. HSA distributions are tax-free if they are used to cover medical expenses, so clients can maximize the tax-preferred treatment of the HSA if the funds are eventually spent on qualified medical expenses. Despite this, there is no actual requirement that HSA funds be withdrawn to cover medical expenses.
In fact, upon reaching age 65, the client can withdraw the funds for any purpose without penalty. The income will be taxable as ordinary income in the same manner as funds that are withdrawn from a traditional IRA. Conversely, funds withdrawn to cover nonmedical expenses before the client reaches age 65 are subject to a 20% penalty in addition to the otherwise applicable ordinary income tax rate.
Because unused funds in the HSA never expire, annual contributions can be left in the account to grow on a tax-deferred basis for years if the funds are not needed to cover medical expenses—much like IRA funds.As a result, many clients can accumulate substantial account balances that can serve to supplement traditional retirement savings vehicles.
While HSA advisors will generally be subject to the same set of fiduciary rules that now apply to retirement plan advisors, it’s important that HSA advisors pay attention to future developments to determine how the DOL rule will be interpreted in order to determine whether any HSA-specific issues will arise.
For more on the repercussions for advisors and clients of the Dept. of Labor fiduciary rule, see ThinkAdvisor’s DOL landing page.
Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.
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