HSAs are awesome, but should we build a countrywide health care strategy around them?
Decisions which impact the future of Health Savings Accounts (HSAs) are going to have a very real impact on my family and also me professionally (I work in HR/Benefits). Thus, I continue to watch recent developments carefully to glean what changes may be in store regarding HSAs.
Recently, the House Republicans approved a proposal for the ACA replacement plan, aptly named the AHCA. We were all expecting big changes, right? Well, they are in there. New ways to calculate subsidies? They will be age based not income based. Higher premiums for older individuals? Older enrollees can be charged 5x more instead of 3x more than younger . Pre-ACA era implications for going without coverage for too long? Yep, that 63 day rule may be coming back, too.
It’s a lot to weed through and since nothing is final, all we know for certain is that ongoing debate and negotiations will continue to shape the final law. The plan may certainly fall apart and the Republicans may have to go back to the drawing board to get enough consensus to finally pass something.
For planning purposes, I’m specifically interested in any changes which effect HSAs since we are such big fans of these accounts. Sadly, although it was rumored to be changing, the current proposal does not eliminate the need to have a high-deductible health plan in order to have access to an HSA.
Health Saving Accounts (HSA) Are Pretty Awesome!
We are just as concerned as the next person about the future cost of health care. We max out our HSA as part of our retirement saving strategy because there is no better way to save for future health care expenses. Plus for now, our employers offer us a little help in the way of employer contributions into our HSA which helps us even more.
Not that long ago, we also wrote about 3 changes that would make HSAs even more awesome. Looks like some of our wish list may become a reality but we’ll watch and see.
Today I’m not talking about how great HSAs are though. I want to talk about two disturbing trends in how HSAs are already used in America today. HSAs were signed in to law back in 2003. So they’ve been around for over a decade now. They have certainly become more popular (is that because employees/individuals have latched on to their benefits, or rather more employers are reducing choices and only offer an HSA compatible health plan to save money)?
Some Unfortunate Truths about HSAs:
If HSAs are so awesome, why wouldn’t they be an ideal part of the U.S. health care strategy going forward?
Unfortunately, there are currently some problems with HSAs:
- Not everyone has access to them. (the proposed changes do not relax the rules surrounding access to HSAs. You would still need to have a High Deductible Health Plan)
- Those that are eligible to contribute are not always able to fund them fully. (If families cannot afford to use/fund them, HSAs may continue to benefit only a small segment of the U.S. population – you can read this as the wealthy people)
- Finally, long term tax and saving benefits are being unrealized for the majority of HSA owners.
It’s this last bullet point that I’d like to delve a little deeper into. HSAs are indeed pretty awesome, but data reveals that not everyone is using them to their full potential. Are you one of them?
Not everyone is using HSAs to their full potential. Are you one of them?
Case in point, let’s look at Devenir Research’s 2016 Year-End HSA Market Statistics and Trends Executive Summary which was recently published in February. Most people are not familiar with Devenir, but they are a large provider in HSA solutions. In fact, one of our personal HSA investment accounts is managed by Devenir. They routinely provide research reports based on data collected from other HSA providers which are available to the public.
* Click here for the full report from Devenir
Reality #1: As a saving vehicle, most HSA users are unable to save for future health care costs.
Only 22% of HSA contributions are rolled over for future years.
Here is a chart showing that the vast majority of HSA contributions are withdrawn annually.
Do you think this is because Americans don’t anticipate significant health care costs in retirement? Doubtful. I think it’s more reflective of the fact that folks can’t pay for current health care expenses without using their HSA funds right away.
Note in the chart the steady increase over several years in both contributions and withdrawals? This shows that HSAs are becoming more popular (or becoming a necessity as more employers adopt high-deductible health plans). Look at the last set of bars. The carry forward amount has actually been declining over the last three years.
What is troubling about this trend is that if HSA money is needed right away, in many ways it’s no better than a Traditional Health Care Flexible Spending Account which must be used by the end of the calendar year (some plans allow for a short grace period or rollover of up to $500). One of the great advantages of HSAs is that the funds are not subject to the Use-It-Or-Lose-It rules like traditional FSA options. That’s one of the reasons why we all love them right?
HSA providers want us to view these accounts like supplemental 401(k) plans. And they certainly can be. For high-earners who want to reduce current taxable income and shelter assets for future use on a tax-favored basis, they can be powerful saving tools. You get a tax break now when you contribute to them and if you can keep your hands off the money, it also grows tax free as well. These are the commonly touted first and second tax advantages to HSAs.
What the chart above is showing however, is that most people can’t afford to cultivate the 2nd tax advantage. If you take the money out almost immediately, there is little to no time for any growth to occur. Therefore, there are no tax advantages realized other than the immediate reduction in federal income and FICA taxes.
This trend results in only 22% of the funds being carried over and therefore available for future expenses. Withdrawals are subtracting the majority of the money going in each year.
The third tax advantage is that if you use the withdrawals for qualified health care expenses, you don’t pay taxes on those funds when you need to pull them out.
How much of your HSA did you ‘carry forward’ into 2017?
Let’s take this to the next level and look at another troubling reality:
Reality #2: The Vast Majority of HSA assets are not invested
Not only are people pulling the bulk of their HSA money out right away, they are also not investing their balance. Is this because people don’t know about investment opportunities?
I have a few theories on this:
- I think just like with many personal finance decisions, people tend to loose track and allow time to go by without revisiting their balances and thus investment opportunities. They may have good intentions, but it simply slips their mind.
- As we discussed above, many families simply need the money right away and their balances may not reach the minimums needed to start investing the excess (most providers have a minimum balance of around $2,000 to invest)
- Participants may be just as fearful about investing risks in their HSAs as they are in their 401(k)s and other saving accounts. Invested portions of HSAs are not FDIC insured. Does knowing that trouble you?
Although it has grown substantially over time, a relatively low percentage of assets are being invested. It’s a lot of money to be sure. At $5.5 billion (2016), it’s still only 15% of overall HSA assets.
If you have been contributing to an HSA and you are fortunate enough to be able to minimize your withdrawals for current health care expenses, how much of it should you invest?
Most providers have minimums around the $2,000 mark. You may not want to invest every possible penny you can, though. What if a big health bill did suddenly pop up? If your strategy is to pay for it with after-tax dollars to preserve your pre-tax growth space, that’s a great idea but it assumes you have a cushion or an emergency fund available to do so. If you can’t afford to do that and you have insufficient emergency funds – it may be a good idea to hold back at least the amount that you need to satisfy your annual deductible plus a little more. This allows for quick liquidity. Having to sell your investments to pay for a sudden health care expense may not be ideal depending on what is going on with the market.
How much is sitting in your HSA right now as cash? Would you sit on 100% cash in your 401(k)?
Are Some People Misusing HSAs?
How can an HSA be misused? Well, they are intended to be used for health care expenses. Some people view using these funds for other purposes to be a hack-of-sorts and I’m not talking about my fellow early retiree hopefuls. We like that you can use your HSA funds after age 65 and pay regular income taxes on the withdrawals if you need to (want to?)
If you are under the age of 65, the ACA currently imposes a 20% penalty to use HSA funds for any other purpose. That 20% is supposed to be a deterrent right? I wonder if employer contributions are being sucked out of HSAs by people who are desperate for the money. If your income is low and you are subject to 0 – 10% income taxes, a 20% penalty may not seem that bad to have access to your employer’s generosity?
For example, my company offers an annual HSA deposit of $1,500 for family coverage. Employees can put in more up to the combined IRS limit of $6,750 which unfortunately most participants don’t do. If you are tapped out for money, that $1,500 looks pretty appealing. It’s pretty easy to withdraw the HSA funds and worry about reporting the taxable withdrawal later when you file your taxes. If you pay no federal income taxes to get access to that $1,500, you will have a future tax bill of $300 (20%). So you net $1,200. Even if you pay just 10% federal income tax plus the 20% penalty, you still end up with $1,050 after taxes.
Are people doing this? Draining their HSA for non-health care purposes? If so, it likely means they cannot afford a doctor visit when someone in the family does get sick.
What are the Proposed HSA Specific Changes?
(Let’s keep in mind, that nothing is final. These are just current proposals)
- New HSA contribution limits may be equal to HDHP annual out-of-pocket limit which will significantly increase the amount you can save into an HSA up to $6,550 for self-only coverage and $13,100 for family coverage (increasing the contribution limits was one of the 3 wishes we had for HSAs)
- May loosen rules to allow for certain Over The Counter (OTC) purchases and alternative medical treatments with HSA funds
- Allow spouses to make catch-up contributions (this is another one of the changes we wrote about last year)
- Allowing a 60-day window to set up an HSA after coverage under an HDHP begins (with tax benefits backdated to start date)
- Decrease the penalty for using HSA money for non-health care related spending (it’s currently at 20% under ACA and reported to go down to 10% – this may make withdrawals for non-health care uses more prevalent)
- Related proposal: the traditional FSA annual contribution limit would revert to $5,000. Will employees be encouraged to switch back to lower deductible health plans and use Traditional FSA accounts instead?
It looks like the new administration is supportive of HSAs and likely to keep them around. This is good news for early retirement seekers. We can really get behind the flexibility that they provide. They come with great tax advantages and it looks like HSA users like ourselves may be able to stash more pretax money into them. If you have access to an HSA through your job, you should really consider funding it up to the maximum allowed, letting it carry over, and investing a significant portion for maximum growth.
It is troubling that only a minority of users are able to (1) save unused HSA funds from year to year and (2) even fewer still are using the investment features.
Bottom line is that we already have HSAs today but many Americans are not using them to their maximum potential.
The reasons are similar to why many can’t maximize other retirement account savings. Personal choice, heavy economic pressures, real and current health needs, and perhaps lack of education could possibly explain these two trends. So is building health care reform around HSAs a sound way to solve our larger problems? I’ll certainly take advantage of the ability to save more money on a tax-favored basis, but I worry about all the people who won’t be helped by these changes.
What are you most excited or fearful about with respect to proposed HSA changes? If you have an HSA now, are you able to preserve it for future years? Is preserving your HSA money and investing the balance a priority for you?