Back in December 2003—well before there was an Affordable Care Act, let alone talk of repeal and replace—then-President George W. Bush created health savings accounts (HSAs).
Still scarcely understood, HSAs have nonetheless grown in popularity. According to the Devenir Group, a Minneapolis-based industry organization, there were nearly 17 million HSAs, with an aggregate value of more than $30 billion, at the end of 2015, the most recent results available.
But as health care continues to be debated in Washington, are HSAs still relevant? More important, are they a good idea for your clients?
HSAs For Retirement Planning
HSAs are only for people with certain high-deductible health plans (HDHPs). They allow account holders to put aside money to help pay those high deductibles and other medical expenses later, as needed. But advocates insist they are also great savings and retirement-planning vehicles.
There are several reasons. First, money that goes in can be deducted from federal income taxes. Plus, it grows tax-free. And it can be withdrawn tax-free at any time, if used for qualified medical expenses. “HSAs are the only account type that gives you the tax trifecta,” says Christopher Hershey, a senior financial planning analyst at eMoney Advisor in Radnor, Pa. “Simply put, they are the most tax-efficient savings vehicles available.”
HSAs are similar to flexible spending accounts (FSAs) with one important difference: HSAs are not use-it-or-lose-it. “There’s no requirement to deplete the account by a specific date,” says Tim Steffen, director of financial planning at Baird in Milwaukee. “You can use it to pay for any health-care expenses incurred after the date you fund it. This means you can fund it today, let it grow during your working years, and then take withdrawals later in life for expenses you incurred in previous years.”
Jack Towarnicky, executive director of the Plan Sponsor Council of America, a Chicago-based industry group, further notes that HSAs compare favorably to 401(k)s. “Compared to a 401(k) plan, your HSA contributions and any employer contributions are pretax not only for federal income-tax purposes … but also for Social Security and Medicare tax purposes, FICA and FICA Med,” he says. “Similarly, all monies contributed on a tax-preferred basis coming out of a 401(k) are taxed as ordinary income, while HSA monies used to cover out-of-pocket medical expenses and certain insurance premiums are received tax free.”
There are, however, a few limits to keep in mind. First, you must have a qualified HDHP—that is, a health plan with a deductible that’s greater than $1,300 for an individual ($1,350 in 2018) or double that for a family. And not all HDHPs are actually HSA eligible. It’s a good idea to double check.
Second, HSAs have an annual contribution limit. Through April 15, 2018, the maximum individual contribution is $3,400 per year and the maximum per family is $6,750. (The annual limits inch up for the 12 months preceding April 15, 2019, to $3,450 for individuals and $6,900 for families.) Those 55 or older may contribute an additional $1,000 per person per year.
Contributions can be made through a payroll deduction or separate deposits. Some prefer to transfer funds directly into an HSA from an IRA, which can be done only once in a lifetime without incurring a distribution penalty or tax. Note that only your personal contributions count toward the tax deduction; if an employer (or loved one) contributes, that amount doesn’t count toward your individual tax deduction, though it does count toward the annual contribution maximum.
Also, you can’t contribute to an HSA if you switch to a nonqualified plan, are listed as a dependent on someone else’s tax return, or go on Medicare. You can keep your HSA savings, but you can’t contribute new funds. The same goes for retirees who receive Social Security, since they’re automatically enrolled in Medicare Part A.
Not All HSAs Are Alike
As uniquely useful as they may be, HSAs vary in the range of investment choices offered, the fee structures and other important details. While most financial institutions that offer HSAs don’t charge any annual fee, that’s not always the case. Do your research.
“Financial institutions specializing in HSAs are best suited for this kind of plan,” advises Chris Ure, chief executive and managing director at HighTower Boca Raton, a financial planner in Boca Raton, Fla. “[They] give the consumer more complete access to information [and] disbursements, in a user-friendly environment. These institutions usually have lower administrative costs because of their volume of business.”
While many banks might offer HSAs, those that specialize might have a strong relationship with the HDHP carrier, he says, “resulting in discounted services. In other situations where plans are self-insured, the third-party administrator may also have a strong relationship with a financial institution. HSA funds can also be invested in other types of securities, which requires high quality professional guidance.”
Not For Every Client
Still, HSAs aren’t necessarily appropriate for every client. “HSAs don’t seem to make sense for families who need frequent and/or specialized medical care,” observes Brian Spinelli, a senior wealth advisor at Halbert Hargrove in Long Beach, Calif. Rather, he says, they are best for “healthy people who don’t use the doctor often and want to keep more of their premiums.”
Assessing whether they’re right in a particular situation can be tricky. “Illness is unpredictable and could end up costing someone with a high deductible plan more than someone with traditional health insurance,” says Tim Hewitt, a senior wealth advisor at the Wiley Group in Conshohocken, Pa.
Another concern of his: Some people focus so strongly on HSA savings that they neglect their own health. “People can feel pressured to grow these accounts, which can limit the desire to use funds for care,” says Hewitt.
There are other potential shortcomings. For one, not all states allow an income-tax deduction for HSA contributions. “For example, California doesn’t allow the pretax contribution to reduce your state income taxes,” cautions Spinelli.
Another drawback, he says, is an added degree of complexity. “You must show your insurance card and pay with an HSA card when you visit the doctor,” he explains. “Medication can cause another issue as those costs are included in reaching the high deductible. Patients can end up with a surprise if they don’t understand how medicine should be paid for under the high-deductible plans.”
What’s more, although the list of qualified medical expenses is extensive, any withdrawals for other purposes are taxable and may be subject to a 20% penalty. “It can be expensive to access these accounts for non-health-care purposes,” says Baird’s Steffen. “The 20% penalty is waived once you reach age 65, however.”
A Growing Employee Benefit
Despite the complexities and limitations, more and more employers are offering HDHPs and HSAs to employees as benefits. “About 50% of employers nationwide offer HSAs,” reports Steve Christenson, executive vice president at Ascensus, a provider of retirement and college savings plans. “As you might expect, the offering improves as the size of the employer increases. This follows a parallel pattern for employers adding an HSA contribution on behalf of their employees.”
Some employers go even further. They “seed HSAs with contributions to help employees start a savings plan,” notes Harvey Cotton, a principal in the tax and benefits practice at Ropes & Gray, a Boston-based global law firm. Others, he says, also “ask employees to focus on the premium savings each month as a means for those employees to start contributing to their HSAs directly out of their paychecks. Once employees start contributing from this premium savings, it may be easier for them to contribute on an ongoing basis.”
But employers and employees alike often need to be brought up to speed. “Those who are not well informed may not save enough in [their HSAs] to cover the high deductibles,” says Thomas Mingone, managing partner at the Capital Management Group of New York. HSAs, he adds, require “the discipline to save the difference.”
Not Without Controversy
Despite widespread support, HSAs are clearly not entirely free of controversy. Critics charge that they unfairly benefit the affluent—a reputation that Evan Powers, a certified financial planner at Cypress Financial Planning in Charlottesville, Va., dubs “probably somewhat deserved.”
Powers holds that HSAs are “amazingly useful” and offer more advantages than people may realize, but they do tend to favor those who can afford the risks inherent in carrying a higher deductible, those who “can afford to effectively self-insure at lower levels of medical expenses,” he says. “Furthermore, since the benefits of HSAs come purely from tax savings, their benefits are also much greater for those whose tax brackets are already high.”
On the other hand, many average folks who could benefit from HSAs don’t. “Voya’s research found that only 6% of baby boomers plan to utilize an HSA to pay for health-care expenses not covered by Medicare,” notes Mike Berry, a Des Moines, Iowa-based certified financial planner at Voya Financial. “This is such a huge missed opportunity, especially for low- to middle-income individuals.”
Voya doesn’t necessarily advocate HSAs over other retirement vehicles, Berry hastens to add, but it does advocate for better financial education and understanding.
“Middle-market families need to utilize all the tools available to them if they want to have a good chance of covering out-of-pocket health-care expenses in retirement, which are estimated to be about $260,000 for the average couple,” he says. “Advisors and employers need to reinforce the need for middle-income individuals to maximize this benefit.”
Given the current political turmoil, though, perhaps it’s surprising that HSAs have remained largely safe from partisan rankling. “[They’ve] grown dramatically since their inception, through Republican and Democrat administrations,” affirms Dr. Kathryn (Katy) Votava, founder and president of Goodcare.com, a health-care advisory in Rochester, N.Y.
Still, in this ever-changing regulatory environment, it’s prudent to “keep educated and know where to go to get questions answered,” she says. Clients shouldn’t worry, however. “So many other aspects of the health-plan marketplace have changed over time,” she says, “[but] HSA regulations have changed very little.”