HSAs, an adviser favorite, just don’t get much love

Health savings accounts are one of the top recommendations advisers make for clients, but the savings vehicles are scarcely used — and when they are, they are almost always treated like checking accounts.

As every financial professional worth their salt knows, HSAs are a unicorn in the tax world. The accounts are funded with pretax income, grow tax-free and are not taxed when used for eligible expenses — the “triple tax” benefits for which they are so renowned. They represent one of the most efficient ways to squirrel away money for retirement.

But they are also kneecapped by their pairing with high-deductible health plans, which are not always optimal for people who regularly anticipate big medical bills.

And while more people have opened HSAs, largely as more employers have opted for high-deductible plans, they are used more like checking accounts than as the long-term saving and investing vehicles they were designed to be.

The pandemic also appears to be having some consequences for HSA use, with those affected by job loss depleting their accounts and those who have remained employed being able to save more than ever, financial advisers say.

FROM EXPERIENCE

“Health care now is extremely expensive, so to have the safety net in place is very good,” said Sydney Schnee, 27, a pharmacist living in Ohio, of her HSA. Schnee began contributing to the account when she started her job about eight years ago, and the employer match has helped build the balance. Once she built enough assets to cover the plan’s $2,500 deductible, she started investing contributions above that amount, she said. She primarily uses the account to pay for prescriptions, though she plans to use it in the future for the cost of having a child, she said.

“I’m very healthy, and all my preventative appointments are covered,” she said.

Some account holders are unaware of the ability to invest, however.

“While some of my clients have heard of them, very few are utilizing them to their full potential before working with me,” said Amy Hubble, principal investment adviser at Radix Financial, in an email. Often, that is because employers limit changes to HSAs to an annual basis, and few are set up to allow automatic contributions and investments, Hubble said. There is also a lack of basic education about HSAs, and having to work with HSA-specific custodians, rather than online brokerages and major RIA custodians further complicates things, Hubble said.

SOME BACKGROUND

HSAs were codified the 2003 Medicare Prescription Drug, Improvement and Modernization Act. Unlike Flexible Spending Accounts, or FSAs, with which HSAs are often confused, assets in HSAs do not have to be used within a calendar year, and they are portable. However, HSAs can only be funded while a worker is in a high-deductible health plan, though employers in some cases make matching contributions for their employees. HSA providers often require that customers fortify their accounts with several thousand dollars before assets can be invested, so that people are prepared to cover high deductibles if need be.

The federal government defines “high deductible” in 2021 as a plan with a minimum deductible of $1,400 for an individual and $2,800 for a family. The maximum out-of-pocket costs for such plans are $7,000 for a person and $14,000 for a family.

This year, the annual contribution limits for HSAs are $3,600 for an individual and $7,200 at the family level. People 55 and older can increase contributions by $1,000.

Like 401(k)s, HSAs let people invest in mutual funds, though the range of investment choices for HSAs are often more limited.

If an accountholder dies and has an HSA balance, the assets can be transferred to a surviving spouse. If the deceased’s beneficiary isn’t a spouse, the inheritor gets a taxable distribution.

DO AS I SAY, AND AS I DO

Financial advisers are eager to say they personally use the accounts, both as checking accounts and retirement savings vehicles.

“We used it [to pay] for our daughter’s birth last year,” said Michael Hakimi, owner of Black Dog Financial Planning. “The hospital that we went to allows you to pay off the pregnancy bills over a year or so.” His wife, Katie, took contributions out her account as soon as they were posted, periodically paying the bills down, he said. While that strategy didn’t have the benefit of allowing assets to appreciate tax-free, the upfront tax benefits were worth it, he noted.

Another adviser, Nadine Burns, CEO of A New Path Financial, has medical plan with a $13,000 family deductible.

“We wanted to be sure we had that amount in the HSA in cash, so it is invested in a money market account. Anything over the $13,000 we invest per our risk tolerance,” Burns wrote in an email. “We never use the funds for small medical costs, and our goal is to take it out at age 65 to pay for Medicare copays and plans we might need.”

WHO’S USING THEM

The pharmacist, Schnee, is among peers. Younger workers have the highest rates of HSA ownership, according to data from consumer research firm Hearts & Wallets. Among millennials, 17% of households report having HSAs, compared with 16% of Gen Xers and just 6% of Baby Boomers, that firm’s data show. Millennials also contribute at the highest rate, with an average of 5% of their savings directed to HSAs, while that rate is 4% among Xers and less than 2% among Boomers.

Families are also more likely have HSAs than those without children. In households in which some children are 21 or younger, 18% of parents have between 1% and 10% of their savings held in HSAs, while another 18% have 11% or more of their savings in the vehicles, according to Hearts & Wallets survey data. Meanwhile, 11% and 4% of households without children reported similar HSA allocations.

As of the end of June 2020, there were more than 29 million accounts in the country, only about 1.5 million of which included any invested assets, according to data from HSA research and consulting firm Devenir. However, those who use their accounts to invest had considerable balances, at more than $15,000 on average.

Total HSA assets were about $73.5 billion, less than a quarter of which were invested, at $17.6 billion, the Devenir data show. Those figures are up dramatically from 2014, when total assets surpassed $24 billion, the firm reported.

HANG UPS AND HIGH DEDUCTIBLES

One of the top reasons for avoiding HSAs are the high deductible plans with which they are paired.

In focus groups with consumers, people said found the concept of HSAs — and their tax benefits — as almost too good to be true, said Laura Varas, CEO of Hearts & Wallets.

The same did not hold for high deductible plans.

“There was this point that an HSA is good for healthy people and the implication that it is not as good for unhealthy people,” Varas said. “Everybody liked the triple tax benefit … Many wished that it was available outside of a high deductible health plan.”

Results of a survey of 1,000 high deductible health plan policy holders that was published in January by Insure.com found that nearly half, 46%, thought their overall medical coverage costs increased as a result of being in such plans. Further, 40% of people reported having delayed seeking medical care because of the costs of deductibles.

A 2018 study by the Employee Benefit Research Institute similarly found that one in three people in high deductible plans has put off medical care because of cost, compared with one in five traditional insurance policy holders who have done so.

COVID-19 EFFECTS

People who have faced unemployment or financial strain during the pandemic likely have been turning to their HSAs to fund medical costs, even if they were used to paying bills with cash.

“I have seen more people tapping these accounts,” Marsha McClary, found of ROI of Life, in an email. “In doing this, you forgo the most powerful HSA benefit of tax-free investment growth. With HSA contributions capped at $3,600 per individual or $7,200 per family for 2021 it’s difficult to make up the balance later.”

But many of those fortunate enough to remain employed have found the ability to save easier than ever, advisers said.

“With my financial planning clients, eligibility for HSAs is one of the first things we determine,” wrote Dan Granucci, president of Iron Path Wealth Management, in an email. Many have been able to save more, and for them, “removing HSA spending is the best thing they can do,” he said.

Another adviser, Dominique Henderson, founder of DJH Capital Management, said he has also seen clients spend less than they usually do.

“I’m recommending that the surplus be used to take advantage of vehicles like this,” Henderson said in an email. “If you think about a 30-year-old client consistently contributing the annual maximum in growth stocks or mutual funds … at age 65, they could pretty much fund medical care or long-term care.”

[More: Beware: Enrolling in Medicare can nix contributing to an HSA]

SAVE THOSE RECEIPTS

Even if you pay in cash for a prescription, there’s nothing stopping you from getting that reimbursed years, or even decades, later from HSA assets, advisers noted.

“As long as you archive receipts, you can use those benefits later for a qualified expense,” said James Hnilo, principal of Sage Wealth Planning. “That’s where it gets to the power of the [HSA] tool.”

The accounts have another plus for retirees — withdrawals for ineligible expenses. After age 65, an HSA is comparable to a traditional IRA, wrote Kaleb Paddock, founder of Ten Talents Financial Planning, in an email.

“Once clients learn that HSAs are the purest form of income contribution … they work hard to maximize their annual contribution,” Paddock said. “They can still withdraw for qualified health expenses tax-free, but if needed they can make a penalty-free withdrawal subject to income tax rates, similar to a withdrawal from their traditional IRA.”

Even while younger workers are more likely to have HSAs, they are also more likely to use the accounts routinely to pay expenses, rather than footing medical bills out of pocket and letting assets in the accounts grow, advisers said.

“Almost every one of my clients that use [an HSA] use it like a checking account,” said John Bovard, owner of Incline Wealth Advisors. Depending on one’s income tax bracket, “you’re basically paying your medical bills at a 25% discount.”

Of course, building up an account balance is not a bad idea either, should a big-ticket medical procedure arise.

“They’re almost essential for everyone who has the opportunity to use them,” Bovard said. “At some point in our life, not matter how healthy you are, something might come up.”