Financial Planning, Retirement

Are HSAs Being Used Optimally?

1/12/18 8:00 AM

iStock-593332270.jpgYesterday we learned that rising healthcare costs are a challenge for Americans of all ages. It therefore may be useful to review an often underutilized tool that can help people deal with this type of inflation risk, i.e. a health savings account (HSA). Indeed, the Internal Revenue Service (IRS) defines an HSA as a tax-advantaged trust or custodial account that is set up with a qualified HSA trustee to pay or reimburse certain medical expenses. The main benefits of HSAs are that contributions are deductible from taxable income, contributions can grow (from interest or other capital earnings) tax free, and withdrawals are tax exempt as well, as long as for qualified medical expenses.

As a result, HSAs encourage setting aside money for the future and help people avoid having to dip into their long-term retirement savings in the event of an unforeseen medical expense. In order to take advantage of an HSA, individuals must be covered under a high-deductible health plan (HDHP), which rising medical costs and the Affordable Care Act’s “Cadillac tax” have forced many employers to use or at least consider. There are annual limits to what can be contributed to an HSA, which the IRS raised by $50 for individuals and $150 for families in 2018. Only around one in eight account holders, though, actually contribute the fully allowable amount each year.

More importantly, contributed funds roll over and accumulate year-to-year if they are not spent, therefore making HSAs a potentially powerful savings vehicle. In fact, an analysis by the Employee Benefits Research Institute (EBRI) estimated that an individual who saves in an HSA for just 10 years could accumulate between $53,000 and $68,000, depending on the rate of return realized and on the contribution rates assumed, and as much as $1.1 million over a 40-year horizon. However, another EBRI study found that only 3 percent of HSA owners actually invest their money, while the rest simply leave their account balances in cash, thereby missing out on potential tax savings.

One reason this occurs is because many account owners view their HSA as nothing more than a specialized checking account used only to pay for deductibles, coinsurance, and other out-of-pocket expenses. Another obstacle is that in order to invest, HSA owners often must have a minimum account balance. EBRI researchers said that “It is possible that rules requiring minimum balances may have prevented owners of relatively new accounts from investing as the accounts would not have reached the minimum balance requirement,” but added that “Over time, account owners appear to see the value in investing. In 2016, 11 percent of accounts opened in 2005 had investments other than cash, compared to only 1 percent among those opened in 2016.”



Sources: U.S. IRS, SHRM, EBRI

Post author: Charles Couch