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HSAs May Work Best as Tax Shelters

Is there a better way to make healthcare affordable?

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Healthcare costs are undoubtedly one of the top challenges that retirees face—especially when overall inflation is running hotter than at any time in the past few decades.

Enter the health savings account, which offers an unmatched tax shelter for dollars that can be used to pay healthcare expenses. HSA adoption has increased rapidly in recent years, fueled by the rise of high-deductible health insurance plans.

Industry advocates often position HSAs as a way to build savings that can be used to meet health costs in retirement. And the tax advantages are compelling: HSA contributions are tax-deductible, investment growth and interest are tax-deferred, and withdrawals spent on qualified medical expenses also are tax-free. The triple tax benefit increases buying power, especially compared with drawing down from a 401(k), which is subject to ordinary income tax on contributions and investment gains.

Some lawmakers would like to loosen restrictions on HSA eligibility, contributions, and withdrawals.

The track record of these accounts suggests that they help people with high incomes accumulate tax-sheltered assets that can be used for healthcare and other needs in retirement. But they do little to expand affordability—or coverage—for the broader population. Meanwhile, HSA tax breaks are projected to cost the federal government more than $180 billion in foregone revenue over the next decade, according to the Center on Budget and Policy Priorities.

That said, are HSAs really the best policy approach to help Americans access affordable healthcare?

Who’s Seeing the Most Benefits From HSAs?

In 2023, HSAs can be used by people enrolled in qualifying high-deductible health plans, or HDHPs, with a minimum deductible of $1,500 (individual coverage) or $3,000 (family coverage). Employers and employees can contribute to the accounts, up to a certain limit, which is adjusted annually. For example, this year the combined limit for employers and an individual worker is $3,850, and $7,750 for families. In both cases, an additional $1,000 catch-up is allowed for workers age 55 and older. (This week, the IRS announced a large increase in contribution limits for 2024, driven by higher inflation.) Contributed amounts can be used to meet deductibles and other out-of-pocket healthcare costs in any given year. But contributions can also be saved and invested for the long term.

IRS data shows that high-income people are the most likely to use HSAs—and benefit from them. An analysis by the Congressional Research Service of 2017 IRS data found that tax returns with more than $500,000 in adjusted gross income were the most likely to report individual HSA contributions, and returns between $200,000 and $1 million were the most likely to report employer contributions. Contribution levels fell along with income, and only a small percentage of low-income tax returns contributed.

How about accumulation? Are HSAs proving to be an effective tax-advantaged vehicle for saving dollars that can meet healthcare expenses in retirement? Seven percent of HSA accounts held investments in 2022, and 32% of overall HSA assets are invested, according to an annual study of the HSA market by Devenir Research, a research and consulting firm.

Likewise, a 2020 study by the Employee Benefit Research Institute found that the balance was $2,229 for an accountholder living in a ZIP code in the lowest income quartile, compared with $5,919 for the highest income quartile. Only 3.6% of accountholders living in the ZIP codes of the lowest income quartile had made investments, compared with 11.6% of those living in a ZIP code in the highest income quartile.

The Employee Benefit Research Institute also found race and gender disparities in HSA usage. Accountholders in disproportionately white ZIP codes had an average HSA balance of $5,004, compared with $3,438 and $3,737 balances for accountholders living in disproportionately Black and Hispanic ZIP codes, respectively. Comparing differences by gender, male accountholders (of all races) accrued a balance of $6,517 on average, more than 3 times the average for women ($1,981).

“The lack of accumulation may explain why we don’t see particularly higher rates of investment among some accountholders,” said Jake Spiegel, a research associate at the Employee Benefit Research Institute.

Spiegel notes that some HSA accounts require a certain minimum balance before investments can be made. “And when people have small amounts of money that they may have earmarked for healthcare expenditures, they may not feel comfortable investing their money—in fact, it probably isn’t appropriate for people who rely on that money to pay for healthcare expenditures in the foreseeable future,” he said.

What Could Alternatives to HSAs Look Like?

Republican lawmakers have routinely introduced bills to expand HSAs. For example, the Freedom for Families Act, introduced in the Republican-controlled House of Representatives this year, would increase annual contribution limits and make HSAs available to people not using HDHPs. Lawmakers also have proposed allowing HSA contributions by people enrolled in Medicare (currently, HSA contributions must stop six months before you enroll in Part A).

But critics of HSAs argue that they are not the best use of tax resources when it comes to improving healthcare access and affordability.

“It’s important to realize that HSAs are not free,” says Gideon Lukens, senior fellow and director of research and data analysis at the Center on Budget and Policy Priorities. “The question is, if we have a limited amount of federal resources, do we want to spend those resources on further expanding tax breaks that mostly go to high-income people, or to address our problem with lack of health coverage and lack of affordable health coverage among low- and moderate-income people?”

In his recent brief on HSAs, Lukens weighed the tax expenditures for HSAs against two other potential ways to expand healthcare access to less affluent households:

  • Close the Medicaid coverage gap in states that have refused to expand the program under the Affordable Care Act. In most states, the federal government and states share the cost of Medicaid, but Congress could allow Medicaid-eligible people in these states to enroll directly and foot the entire bill. That could reduce the number of uninsured low-income Americans by nearly 2 million people. Black residents would see the biggest gains, with their uninsured rates falling by 27%.
  • Permanently extend the current enhanced premium tax credits that help people afford ACA marketplace plans. Under the Inflation Reduction Act, enhanced subsidies for people buying their own ACA health policies were extended through 2025; the subsidies are holding premiums down an estimated 53%, according to the Kaiser Family Foundation.

Lukens found that the 10-year projected cost of either of those policies is close to the cost of HSA tax expenditures over the same period.

HSA Ownership in Practice

None of this is to say that overall HSA account ownership is not diverse.

Another Devenir report finds that 78 million Americans had an HSA in 2021, and that one in five people in their 30s have an account. That finding makes sense: Since younger people tend to enjoy better health and are less likely to encounter major out-of-pocket healthcare expenses, they may be less inclined to save money specifically for healthcare. At the same time, they save substantially on health insurance premiums for HDHPs.

Ownership is found across the income spectrum, and 78% of account owners have household income below $100,000. Most of the accumulation is among older households, the report found.

“We’ve found that ownership of these accounts is more diverse than what others have found,” says Eric Remjeske, Devenir’s president and founder.

HSA proponents also note a more general health insurance trend toward higher deductibles.

Indeed, the share of workers enrolled in plans with a general annual deductible in 2022 has increased significantly over time, according to the Kaiser Family Foundation—from 72% in 2012 to 88% in 2022. And the average deductible amount for covered workers in plans with a deductible has also increased over that period, from $1,097 in 2012 to $1,763 in 2022.

KFF reports that 25% of employers offered insurance plans that qualify as HDHPs and offered an HSA in 2022. Among large employers, that share was much higher—51%.

That data might sound like an argument for expanding access—until you consider that 39% of employers offering HDHPs did not make a contribution last year to offset expenses (for single workers), and 32% of workers enrolled with family coverage did not receive a contribution.

Spiegel thinks the debate about the proper role of HSAs will continue for a while, noting that the accounts have only been around for a couple of decades. “We’re still very much in the early days on this, in terms of figuring out where HSAs fit in into personal finances,” he said.

Mark Miller is a freelance writer. The opinions expressed here are the author’s. Morningstar values diversity of thought and publishes a broad range of viewpoints.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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