How to get the most out of HSAs

Health savings accounts can be far more than just a safety net.
By Anslee Wolfe

Most people aren't taking advantage of the full benefits of a health savings account, using it more as a checking account than as the investment vehicle it could be, according to a recent report.

Experts are not surprised, largely because HSAs are still fairly new and many people don't seem to fully understand what the accounts can do. CPAs who are personal financial planners can help by explaining the benefits of HSAs to their clients.

HSAs allow eligible individuals to make tax-deductible contributions into a custodial account where the earnings inside the account are tax-free and the money can be withdrawn tax-free if it is used to pay for qualified health care costs. Those are tax advantages an individual retirement account or 401(k) can't offer.

"The unique financial benefits of health savings accounts need to be better communicated. I am not sure that most Americans, including many who have opened an HSA, realize that these are the only investment options that offer a triple-tax advantage," said  A. Mark Fendrick, M.D., director of the University of Michigan's Center for Value-Based Insurance Design.

But there's a catch: HSAs are only an option for those who have a qualified high-deductible health care plan, which has a lower monthly premium but requires the account holder to pay a certain amount of expenses out of pocket before insurance kicks in. The idea is that money needed upfront for deductibles, co-payments, and qualified medical expenses will come from the HSA.

There is no use-it-or-lose-it rule with HSAs. The money is the account holders' to keep, even if they leave their employer. Because the funds roll over annually, people can build up the funds for medical costs in the future and for retirement. The 2017 contribution deduction limit for HSAs is $3,400 for individuals with self-only coverage and $6,750 for family coverage. Those age 55 and over who are not yet enrolled in Medicare may make catch-up contributions of an additional $1,000 each year. Those enrolled in Medicare may receive HSA distributions but can no longer contribute funds to their HSA account.

Excess contributions (i.e., contributions in excess of the above limitations) are not deductible, or, if made by the individual's employer, are included in gross income. A 6% excise tax generally applies to any excess contribution each tax year it remains in the individual's account. An individual can avoid the excise tax on an excess contribution by withdrawing the excess contributions under the following conditions:

  • The excess contribution is withdrawn by the due date, including extensions, of the tax return for the year the contributions were made; or
  • The excess contribution and any income earned on the excess contribution is withdrawn and the earnings are included the earnings in gross income in the year the excess contribution and the earnings are withdrawn.

If an excess contribution is not withdrawn, an individual may be able to deduct the excess contribution in subsequent years in which his or her contributions are below the HSA contribution limits applicable to the individual for that year. After the individual deducts the excess contribution, it is no longer treated as an excess contribution.

HSA money may be used to pay for any expenses, medical or otherwise, but at a cost if distributions are not for qualified health expenses. Essentially, an HSA can be a retirement vehicle for medical expenses—or for any expenses. However, distributions not used for qualified medical expenses are includible in gross income and are subject to a 20% additional tax. The additional tax does not apply to distributions not used for qualified medical expenses made after the date an individual reaches age 65, becomes disabled, or dies, but the distributions are still includible in gross income. Distributions of excess contributions that meet the requirements to avoid the excise tax described above are not includible in income and thus are not subject to the 20% additional tax.

HSAs can be invested in the same options approved for individual retirement accounts, such as bank accounts, money market funds, stocks, bonds, and mutual funds—but some of those kinds of investments put the money at the mercy of the markets. A minimum balance, typically at least $1,000, is required to invest the funds beyond cash or cash equivalents, according to the Employee Benefit Research Institute (EBRI) in Washington, which may prevent newer account holders from investing.

Know the benefits

With so many options and such flexibility in HSAs, financial advisers can help their clients by making sure they fully understand the benefits of the accounts, said Brent Ulreich, a financial adviser with Hefren-Tillotson in Pittsburgh. He believes HSAs are "practically a necessity" for high-deductible health plans, or HDHPs. For 2017, HDHPs are defined as those with an annual deductible of $1,300 for self-only coverage or $2,600 for family coverage, and an out-of-pocket expense maximum of $6,550 for self-only coverage and $13,100 for family coverage.

"The nature of HDHPs places a significant portion of the overall cost of care on the insured. If care is needed, payment will have to come from somewhere," Ulreich said. "The smart choice is to use an account that the government incentivizes us to use."

As medical costs increase, how to pay for them is a growing concern. This is especially true in retirement, when health care is one of the largest expenses, according to a 2016 Fidelity report. Even wealthy retirees say their top worry is getting sick, according to a recent UBS report that showed while 88% of them feel financially prepared for retirement, less than half feel they have integrated potential health care costs into their retirement plans.

There is "a significant knowledge gap" about the benefits that HSAs deliver for long-term savings, said John Young, senior vice president of consumerism and strategy for Alegeus, a consumer-directed health care solutions company. A 2014 Alegeus survey found that 70% of HSA holders couldn't pass a basic proficiency test about their account.

"As more people use HSAs to pay for their out-of-pocket health care expenses, they will learn about the savings opportunities along the way, filling the gap that exists today," Young said.

More HSAs on the way

HSA-eligible plans are expected to grow as more companies offer them. In 2016, there were 20 million HSAs nationwide with nearly $37 billion in assets, according to a report from Devenir, an independent investment adviser for HSAs. It projects by the end of 2018, there will be more than 27 million accounts, exceeding $50 billion in assets.

An analysis of how people use HSAs over time conducted by EBRI examined 5.5 million accounts with $11.4 billion in assets for the report Trends in Health Savings Account Balances, Contributions, and Investments, 20112016: Statistics From the EBRI HSA Database. The longitudinal study is the first such analysis of how HSAs are being used over time, according to EBRI.

Highlights from the report, released in July:

  • Average combined annual individual and employer contributions increased from $2,348 to $2,922 from 2011 to 2016.
  • Most people appear to be using HSAs to pay for current medical costs, including deductibles and co-payments, instead of using them as investment accounts.
  • Sixty-three percent of HSA owners pulled money out—$1,771 was the average amount withdrawn last year.
  • Very few people—only 4% in 2016—placed their funds in an account besides cash.
  • Most of the accounts in EBRI's database are newer, with the majority—77%— opened between 2013 and 2016.

Paul Fronstin, director of EBRI's Health Research and Education Program and author of the report, said it is understandable that it's taking time for people to warm to HSAs, which have only existed since 2004.

"They're newer, and they're easily confusing," he said. But people are more likely to grasp the full benefits of HSAs the longer they have an account, Fronstin said.

Other findings from the report bear that out:

  • Annual contributions in 2016 were higher the longer a person had an account—$3,658 was the average contribution for accounts opened in 2005. By comparison, the average was $1,290 for accounts opened last year.
  • Over time, account holders appear to see the value in investing. In 2016, 11% of accounts opened in 2005 had investments other than cash, compared to only 1% among those opened in 2016.

People reap the biggest benefits from HSAs if they are able to use them as a savings vehicle not only for current medical costs but also for future health care expenses, even into retirement, according to EBRI. But not everyone can afford to both pay for current expenses and save for future ones.

"The fact is anyone who puts money in is benefiting from it going in tax-free and coming out tax-free," Fronstin said. "It may not have time to build up, but it may just make a difficult position a little better."

Anslee Wolfe is a freelance writer in Colorado Springs, Colo. To comment on this article, contact Chris Baysden, senior manager of newsletters at the Association of International Certified Professional Accountants.

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