HSA participants fail to take full advantage of tax trifecta

Health savings account owners tend not to take full advantage of what one financial advisor calls the tax "trifecta" the vehicle offers, according to a recent study.

Account holders can make tax-deductible contributions to their HSAs, which can be used in high-deductible health care plans. Account funds can grow tax-free and be withdrawn tax-free if they’re used for medical expenses.

The tax benefits of HSAs are maximized when a participant makes the highest contribution possible — $3650 for an individual and $7,300 for a family in 2022 — staves off tapping the funds until retirement and invests their balances in assets other than cash, according to the Employee Benefit Research Institute.

But the organization reported in a recent study that the average employee and employer combined contribution in 2021 was $927 less than the statutory maximum for individuals and $4,527 less than the maximum for families. It also found that only 12% of account holders invested their funds in assets other than cash.

“Average contributions were well below the statutory maximum, most accountholders take a distribution from their HSA, and relatively few accountholders invest,” Jake Spiegel, an EBRI research associate, said in a statement.

The EBRI study is based on the think tank’s database of 13.1 million HSAs. The average balance in the accounts was $4,318 in 2021.

But there was some good news in the survey, Spiegel said, noting that the 12% of HSA users who invested their assets in 2021 was up from about 4% in 2015.

“It seems to be slowly but surely growing in popularity as a wealth building tool,” Spiegel said in an interview.

In email newsletters this tax season, financial advisors have been reminding clients that they have until the tax filing deadline in April to make HSA contributions that affect their 2022 taxes.

Richard Pon, an advisor and CPA in San Francisco, educates his clients about using HSAs.

“You get the trifecta,” Pon said, referring to the triple-tax benefit. In response, clients “are like, wow: You get three benefits?”

Thanks to changes ushered in by pandemic relief legislation, HSA funds can now be used to cover many over-the-counter drugs.

“That’s the biggest sell right now,” Pon said.

He also stresses to his clients that HSAs can augment individual retirement accounts. If money is withdrawn in retirement for non-medical expenses, an account holder must pay taxes on the funds but no penalty is assessed.

“It becomes an extra savings vehicle,” Pon said.

The longer someone owns an HSA, the higher their contributions usually are, and they’re more likely to invest their assets, Spiegel said. Longevity in the accounts is important because sometimes the funds have to be built up to meet a minimum level required for investing.

A financial advisor's encouragement to make the most of an HSA can increase the utility of the vehicles for account holders.

“That’s a pretty powerful behavioral nudge,” Spiegel said.

The EBRI database contains about 40% of all HSAs, Spiegel estimates. The total number of HSAs is likely about 33 million. The 13.1 million HSAs that EBRI tracks contain a total of $39.5 billion in assets.