The Benefits and Rules of the Health Savings Account (HSA)

Over the past few years, one of the hottest topics has been the rise of inflation throughout the economy. Inflation impacts our day-to-day financial lives in numerous ways, good and bad, and it has a significant impact on our investments over time. It's a silent killer that affects our spending habits, retirement income, and other financial goals that we have.

Hello, everyone, and welcome back to the Retired-ish Podcast. My name is Cameron Valadez. I am a practicing, certified financial planner and enrolled agent. I want to go over a topic that might seem rather boring and unimportant, but it's absolutely critical to understand when it comes to your money, your livelihood, and your future plans. And that is inflation, which is also, I think, one of the most widely misunderstood topics in all of finance.

We also have a new listener question about Social Security and pensions and the effect of the WEP, or W.E.P. and GPO provisions, and how those can affect your claiming decisions if you do have certain pensions, which we will tackle at the end of the show.

All right, let's talk inflation, which is important because there are two things other than market or economic volatility that can cause you to run out of money faster than you realize. One is taxation, and the other is inflation. At times, inflation can be very difficult to notice, even completely elusive. There are periods of time where we don't feel the effects in our day-to-day lives because although prices of the goods and services we purchase generally go up over long periods of time, they may do so at a fairly low to moderate pace for stretches of several years or more.

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One recent example is, let's say, the early two thousands through the year 2020. It's actually been much longer, but let's just use this in my example, nearly 20-plus years, where inflation was essentially ignored since it grew at a relatively slow pace. And we're humans, so we inherently have a sense of what we call recency bias, meaning that we think that things we have experienced recently are just how things will always be, which is most often not the case. And there are other times when we notice it every time we go to the grocery store or the gas pump, as you likely have experienced over the last few years when the pace at which inflation was increasing skyrocketed over a short period of time. Then again, that recency bias creeps in, and many people assume that things will stay this way.

This is why the topic of inflation has once again come to the forefront of investors' and retirees' minds and the financial media at large. Either way, we may notice the true compounding power inflation can have over long periods of time when we have to go purchase, say, a big ticket item such as a new vehicle since we don't realize the changes in prices of things that we don't consistently buy until after several years, if not over a decade later. This is important to understand, especially nearing retirement, since there will absolutely be times throughout the remainder of your life when you will have to outlay lump sums of cash. As I have mentioned on this show many times before, sometimes this is for things you'll hopefully enjoy, like remodeling part of your home, or sometimes it's for things that aren't so fun, like replacing your roof or paying for medical care. It's important to plan early for those unexpected cash outlays and make sure that your money will keep up with the increased costs of these potential expenditures in the future.

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Now, with long-term inflation often comes higher income via higher wages or cost-of-living adjustments on pensions or Social Security benefits and higher rents, for example. People actually expect to get raises and be paid more over time, or landlords expect to be able to raise rents over time, and that it is actually deserved. Which may be true. However, people don't feel like they deserve to pay more for goods and services over time. See how that works?

As Ben Carlson, a popular financial blogger and CFA, notes, inflation is the lesser of two evils, meaning that inflation isn't a good thing per se, but we don't get to enjoy more pay over time via higher wages or rents and getting a higher interest rate on the CD at your bank, while at the same time having prices revert back to previously lower historical levels, otherwise known as deflation. Now, deflation might sound great because that would mean lower prices, but in turn, that would also have to mean lower wages, lower economic growth, and a loss of jobs, which I don't think anyone actually wants. This is because one person or corporation's spending is another person or corporation's income. Higher wages come from higher prices. Vice versa.

In summary, Ben notes that as long as the economy is growing, deflation is quite rare. I couldn't agree more, but this is the premise that a majority of investors, which also includes many retirees, misunderstand. As of late, the media has consistently thrown in our faces what the current rate of inflation is and the rate at which it has been increasing, which over the past couple of years has been higher than in recent history. They typically quote whatever the US Federal Reserve is doing with interest rate policy, such as whether or not they will change interest rates up or down. Leave them the same, what have you. And investors use that to gauge where the Fed thinks inflation is headed in the economy.

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And if the Fed stops increasing interest rates or even decreases interest rates, people tend to think that that means we're going to experience deflation, and therefore prices will magically start going down. This is not the case. These higher costs are here to stay. A burrito from Chipotle is not going back to seven dollars. Do not fall into that trap, thinking prices will eventually come back down to where they were at any particular time in the past.

Although the rate at which inflation is increasing may fall, that doesn't mean inflation itself is going backward. This is kind of a tricky thing to think about at first, but it is so important to have a basic level of understanding of. When doing your financial planning, you have to strongly consider the impacts of inflation and taxes over the rest of your lifetime, not just year to year. You hear me say that on the podcast all the time, and that's because it is that important. And there are so many people that ignore both of those things year in and year out.

00:07:42
If you approach it with a short-term mindset, you're likely to end up making costly mistakes. For instance, in an interest rate environment like today, if you were to allocate too large of portions of your investments that were to be used to supplement maybe your retirement income for the next 20 to 30 years, and you moved it or reallocated it to CDs or short term government bonds because they're currently paying you around 5% with little to no risk, well, you might be hurting your long term plan. These rates are at this level because inflation has been running hot and is also higher. To expand on this, let me give you an oversimplified yet all too real-example. If you took $100,000 of your investments that were invested as part of a portfolio that was going to provide you with adequate retirement income over the rest of your lifetime, and you put it in CDs currently paying 5% per year, here's how that might turn out.

You invest 100,000. You earn 5% over a year, which is $5,000. Then, let's assume you are in the 24% federal tax bracket. You will pay roughly $1,200 in taxes, leaving you with after-tax interest or earnings of $3,800. So now you have $103,800.

But don't forget the effect of inflation, which at a modest average long-term average of 3% would be about $3,144, eating away at your $103,800. This leaves you at the end of the day with a purchasing power of $100,686. This is a very small net return for your $100,000. Inflation, as I said before, is a silent killer. You won't see this sort of impact on your investment statements.

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In fact, you're sort of misled since you won't see the impact of taxes either. The net amount you are actually able to spend at the end of the day and what you can buy with that money is all that matters. At the time of the investment, it felt right because you felt you were taking advantage of the current interest rate environment and reducing your risk by using “safer investments.” However, after the effects of taxes and inflation, you're barely keeping up, and I don't even include potential state taxes. In a situation like this, it may seem like you are reducing risk by taking money you had in stocks or something similar and putting it into something “safe.”

However, these investments that are often considered safe also have a major risk, the risk that the growth doesn't outpace inflation over a long period of time. Outpacing inflation over long periods of time is oh so important for retirees because you will need to increase your income over time as well as have additional money for those one off expenditures I discussed earlier, and they are bound to happen at some point. Ever heard of long-term care? So why do I share this? The point isn't to scare you or say that you should never invest in things like CDs or short-term government bonds because there is definitely a time and place for them.

But instead it's to help you realize this issue sooner than later. When you create a financial plan, and you have identifiable goals, such as a certain amount of retirement income, etcetera, you should invest accordingly to meet those goals. When doing your planning, you don't necessarily want to be making drastic changes simply due to what interest rates or inflation are doing at the given moment in time. But sitting down and looking over what you're currently doing may cause you to rethink how you will combat inflation moving forward. This also leads me to one more point I'd like to make, and that is that it is a dangerous game to try and predict inflation and or interest rates.

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It doesn't matter if it's the so-called expert economist on TV, your financial advisor who trades stocks for you, your so-called successful day trading brother-in-law, or even the Fed chair, for that matter. No one can predict interest rates consistently and accurately, so I urge you not to make investment changes every time there is a different consensus or outlook about interest rates and inflation. There are too many variables in unknowns. If you don't believe me, there's a thing called the Fed dot plot that shows what the various Fed official's projections are for short-term interest rates that supposedly gives insight into their future decisions. But guess what?

They are almost never accurate and have a horrific track record compared to what actually ends up happening. And they are in the business of economic forecasting. The media doesn't help either since they will surely make it seem like whatever the Fed is currently saying or doing is of the utmost importance, but it is not, at least for long-term investors. What they end up doing or saying is reflective of what the current economic and financial trends are in the current economy, which, like I mentioned, is incredibly complex and nearly impossible to predict consistently. So there's always the chance they are wrong or simply change their minds after making any one decision, which I already mentioned before, we have proof of.

Your investments should be made based on your various goals. So if you didn't base your original investment portfolio on the economic outlook at that time, why would you change it later based on an economic outlook at that moment in time? Simply said, don't go down that road. Sorry, I know I rant a lot on this show, but it's simply because I see far too many people trying to get away with doing these things year in and year out, thinking that they will get better outcomes, and it just never works out and then it's often too late. So, I'm trying to help you here and save you from making their mistakes.

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All right, enough about inflation. Let's get to our listener question. This question comes from Michelle. Thank you, Michelle, for sending this because I think it is an awesome question, to say the least, as it is very common but also can be fairly complex and confusing. So I'm going to do my best. Let me try to break this down as best I can and make it digestible.

And her question has to do with what is known as the windfall elimination provision, or WEP W.E.P., and the government pension offset provision, or GPO, when it comes to Social Security benefits. So Michelle asks. My husband and I are trying to plan for when we will each claim Social Security but have heard from former colleagues that our pensions may cause our benefits to be reduced since my husband has not paid into Social Security for years. We will each get pensions from our employers when we retire. How exactly will our Social Security benefits work, and does it matter when we take them? Our Social Security estimates say we will each get over $2,200 at age 67. Thank you.

Thank you, Michelle. As my friend Mark Kohler would say, bless your heart, Michelle. This is a loaded one. There's a lot more information that I would need in order to give you an accurate answer and to answer every part of that question specifically.

But I will do my absolute best since I know there are more of you out there looking for answers on this topic as well. I want to add a disclaimer to this by saying that if you are subject to these provisions or you think you will be, I would definitely reach out to a professional for help, as these provisions can be very confusing and or misleading. And you need to be careful here because we are talking about possible permanent decisions that you'll be making when deciding to claim Social Security or your pension. And secondly, as you may have seen examples of in our newsletter, sometimes Social Security reps even get these rules wrong, so it's always best to at least get a second opinion. So let me start with what these two provisions are.

00:16:28
Then I'll dive into Michelle's question and the specifics. The windfall elimination provision, also known as WEP, is a provision in which your Social Security benefits may be reduced if you are to collect a pension from an employer who did not require you to pay into Social Security via your tax withholding from your paychecks. This is common with people who are part of governmental or government-related pension systems, like a lot of teachers and those who might work for a local county or something like that. However, even if you don't currently pay into Social Security, but you did in a past life, and you are to get one of these pensions, it doesn't mean for sure that you will have any reduction. If you have 30 or more years of substantial earnings paid into Social Security outside of this job or career where you work for the governmental agency, it generally won't affect your benefits. WEP cannot eliminate your benefits entirely, either.

Currently, in 2024, the maximum reduction to your benefits from the WEP provision is $587. However, they cannot reduce your benefits by more than half of your pension. Therefore, if you had, let's say, a pension of $1,000 a month, the most it could be reduced by the WEP provision would be $500, not the max 587. So in Michelle's case, she stated that her husband didn't pay into Social Security. I assume maybe that she did.

00:18:18
If that's the case, she likely won't have any effect on her Social Security benefits and can receive both her pension and Social Security without a special reduction. If Michelle takes her benefits before her full retirement age of 67, that may reduce them due to filing early. But the WEP provision wouldn't come into play. Again, that's if she has been actually paying into Social Security herself. Now, it sounds like her husband would be affected by WEP since she said that he has not been paying into Social Security.

She says he has a Social Security estimate saying he would get around $2,200 a month at 67. But this likely won't happen unless he's worked over 30 years and had enough earnings paid in, maybe prior to working for the government employer offering this pension. This is one of those details I don't have, so I'll just throw out some assumptions here. She mentioned that he hasn't paid in for years, so let's assume he spent the majority of his working life for this government-related employer and has not met that 30-year requirement. In this case, he will be affected, which means that the number Social Security is showing him at age 67 is not reality.

When they send those estimate statements to you, they're not accounting for any potential effects of WEP or GPO for that matter. They won't determine that until you actually go to file. So, this is lesson number one. Don't think that because they sent you an estimate, that is exactly what you're going to get in these cases. That may not be true.

00:20:06
So you need to be careful here. Now, how much will his benefits be reduced? I don't know. This will depend on the size of the pension. We can go back and see if he will have the maximum of the $587 reduction for 2024 or if it will be limited to some extent.

If he will get, let's say, a $ 5,000-a-month pension, he will likely have the full 587 reduced from his Social Security benefits. Also, remember that his benefits will also be based on when he files, which could be anywhere from age 62 to 70. The $2,200 or so was his full retirement age amount, I'm guessing, which was age 67. So the actual WEP calculation is somewhat complex, but just knowing these general rules and max reduction amounts should get you going in the right direction.

Now, let's talk about the government pension offset, also known as GPO. This provision is similar to the WEP in which it might reduce Social Security benefits for a spouse that didn't pay into Social Security and has one of those non-covered pensions. The GPO applies only to spousal benefits or survivor benefits if your spouse were to pass away. Again, it only affects the benefits of the worker who has the pension that didn't pay into Social Security. So in Michelle's case, the benefit that may be affected by the GPO would be her husband's, not her own benefits, since she has been paying into Social Security, I'm assuming, for over 30 years, and she has her own retirement benefit to collect.

00:21:55
If her husband were to pre-decease her, both of these provisions would go away, and she might collect a survivor benefit based on his record that is unaffected by WEP or GPO. But this will depend on the size of her own Social Security benefit as well. Now, the GPO reduction to the Social Security benefit is two-thirds of the non-covered pension amount, in this case, her husband's pension amount. It can reduce the Social Security benefits, and it can actually wipe them out entirely, depending on the numbers. Unlike the WEP, which has that 587 maximum reduction, the non-covered pension, again, is the one that will be received by the spouse who wasn't paying into Social Security.

So let's say her husband's pension is $8,000 a month if the GPO were to apply. So if he were to take a spousal benefit based on her Social Security, which looks like that's unlikely due to the fact that both of the benefits are a similar amount, or if, let's say, Michelle passed away and he was entitled to survivor benefits based on her record, then the benefits might be reduced by two-thirds of the 8000 in my made-up example, which is roughly $5,333. That would be far larger than the expected Social Security benefit Michelle provided of around $2,200. So, in this case, the entire benefit would be wiped out. It's important to note that not everyone's situation is going to look like this.

It ultimately depends on the the size of the non-covered pension, whether you and your spouse have a non-covered pension, and whether or not spousal benefits or survivor benefits will come into play and when. All that being said, I can see some possible creative ways they could each time the claiming of their benefits to capitalize on maximizing their lifetime benefits. But that would require a much more in depth analysis. Hopefully that helps you, Michelle, and everyone else out there in similar situations. If you need a more in-depth analysis, feel free to reach out for a consultation at planablewealth.com. We do this stuff all the time.

00:24:17
So I think we'll wrap up with that today. Keep sending in your questions. If you are concerned about the effects of inflation, taxes, Social Security, and just your overall retirement planning, and you want to nail down a plan that you can actually implement over time and take advantage of the different rules and regulations that are currently in place? Absolutely reach out to our firm, Planable Wealth, even if it's for a second opinion. We are an advisory firm that does comprehensive retirement planning for retirees, and we understand how your finances may be impacted by these different risks and programs like Social Security.

In addition, if you check out our website at retiredishpodcast.com, we are offering a free download for our firm's retirement planning quick guides, which includes multiple flowcharts and resources to help you make decisions and implement some of the things that we discuss on the podcast when you join our monthly Retired-ish newsletter. So be sure to check that out. Plus, you'll learn a ton about retirement planning from the newsletter itself once a month. Easy to digest information right to your email inbox. No spam.

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00:26:21
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