Don’t Settle for a Subpar Health Savings Account

Love them or hate them, it's hard to see health savings accounts losing traction any time soon. Used in conjunction with high-deductible healthcare plans, the accounts have been touted as a way to put downward pressure on healthcare costs. With a fixed pool of their own dollars to spend, the thinking goes, HSA owners might be more judicious about shelling out for healthcare services than would be the case if they were covered by a more encompassing healthcare plan, such as a preferred provider organization.

In reality, however, many people with HSAs do not take full advantage of them, according to a study by HelloWallet, a Morningstar company. Even though HSAs are the only triple tax-advantaged vehicle in the tax code--allowing for pretax contributions, tax-free compounding, and tax-free withdrawals for qualified medical expenses--only a tiny share of HSA owners fund the accounts to the maximum. An even smaller sliver takes the step of investing HSA dollars in anything but a savings account.

It's very likely that most consumers don't fill their HSAs because they don't have the financial wherewithal to do so; indeed, HSA critics point out that the high-deductible healthcare plan/HSA combination is a good fit for the "healthy and wealthy" but is apt to be less advantageous for lower-income workers. But even wealthy consumers may avoid taking full advantage of their HSAs because the HSA their employer has chosen to accompany their high-deductible healthcare plan simply isn't very compelling. It's still early days for HSAs, and many of the accounts are larded with fees: account-maintenance fees and extra costs for investing the HSA dollars in long-term assets, to name some of the key HSA expenses. Relative to 401(k)s, where the landscape is fairly well-lit and well-policed (albeit still in need of improvement), HSAs are a Wild West.

Yet in contrast with 401(k)s, where participants are typically captive in their employers' plans unless their plans allow in-service withdrawals, all HSA savers have a valuable escape hatch. They can periodically move money from one HSA to another via transfer or rollover. Here's a closer look at how to know if an HSA is subpar, and the best ways to get around it if it is.

Valuable Tax Advantages May Come at a Price Based purely on the tax advantages, HSAs appear to have it all over other tax-advantaged savings vehicles, especially for investors who know they will have some out-of-pocket healthcare expenses down the line (um, all of us?). As stated above, HSAs allow for pretax contributions, tax-free compounding, and tax-free withdrawals for qualified healthcare outlays. And even in a worst-case scenario in which an investor needs to tap an HSA for expenses other than qualified healthcare expenditures, the HSA is at least as good as a traditional tax-deferred 401(k) or IRA; it allows for pretax contributions and tax-deferred compounding, and withdrawals for non-healthcare expenses in retirement are taxed at ordinary income tax rates. (One difference is that HSA funds have more stringent limits on withdrawals before retirement age; HSA assets withdrawn prior to age 65 are subject to a 20% penalty unless applied toward qualified healthcare expenses, whereas assets withdrawn from an IRA prior to age 59 1/2 are subject to a 10% penalty.)

Yet HSA expenses and/or shortcomings on the investment front can erode the accounts' prodigious tax benefits. That's particularly true for smaller HSA investors: Not only do flat dollar-based account-maintenance fees (say, $45/year) hit smaller HSA investors harder than ones with larger balances, but interest rates for smaller investors' health savings accounts may also be lower. Thus, it's valuable to conduct due diligence on your HSA.

Be sure to assess the following:

Setup Fees: A one-time fee imposed at the time of the health savings account setup; this fee may be covered by your employer.

Account-Maintenance Fees: These are fees for maintaining your account at the institution, whether a bank or credit union; they can be levied on a monthly or annual basis. Because account-maintenance fees are typically flat fees levied without regard to account size--for example, $2.50 per month or $45 a year--they hit HSA savers with smaller account balances particularly hard. However, they may be covered by the employer, and HSA investors with larger balances may be able to circumvent them altogether.

Transaction Fees: These dollar-based fees may be levied each time an individual pays for services using the health savings account.

Interest Rate on Savings Accounts: If you're using the HSA to fund out-of-pocket healthcare costs as you incur them (or taking a hybrid approach, as discussed here), it's particularly important to keep an eye on the rate of return you're earning on your savings. Many HSAs offer lower interest rates on smaller balances than they do for larger ones; that--combined with the fact that account-maintenance fees are apt to hit smaller HSA savers harder than larger ones--argues for building and maintaining critical mass in your HSA, to the extent that you use one at all.

Investment-Related Expenses: HSA users who choose to invest their balances in long-term assets (i.e., mutual funds and ETFs) can confront a variety of fees. They're on the hook for mutual fund or ETF expense ratios, of course, as well as sales charges if they apply. Additionally, HSA investors frequently pay dollar-based fees to maintain their investment accounts.

Investment Choices: Assess the investment lineup on offer to make sure it aligns with your investment philosophy. Many HSA investment lineups tilt heavily toward low-cost index funds, but others feature primarily actively managed funds, often with higher expenses.

How to Switch Out of a Poor HSA If you've done your homework on your employer-provided HSA and found it lacking, you have three distinct choices.

Option 1: Contribute to an HSA on Your Own As long as you're enrolled in a high-deductible healthcare plan, you are technically free to pick another HSA rather than steering your contributions into an employer-selected HSA. You could then deduct your HSA contributions on your tax return. However, that's more cumbersome and requires more discipline than steering a portion of your paycheck directly into the "captive" HSA. Additionally, HSA contributions made under a salary reduction arrangement in a section 125 cafeteria plan are not subject to Social Security and Medicare taxes, whereas those taxes will come out of your paycheck even if you ultimately end up diverting those dollars to your own HSA. For those reasons, foregoing payroll deductions for an HSA is usually not the best option.

Option 2: Transfer the Money from Your Employer-Provided HSA into Another HSA With this strategy, your HSA contribution is deducted directly from your paycheck and sent to your employer-provided HSA; you can then periodically transfer all or a portion of that balance into an external HSA of your own choosing. (It's considered a "transfer" rather than a "rollover" when the two financial firms deal with one another on the transaction; you never put your hands on a check.) There are no tax consequences on HSA transfers, and you can conduct multiple transfers per year. Note that it's OK to have more than one HSA, so this approach can be particularly effective for employees whose "captive" HSAs feature a decent savings-account option and less-compelling investment options. The employee can contribute enough to the savings account to cover anticipated out-of-pocket healthcare costs, but steer any excess funds into an HSA with better investment options.

Option 3: Roll Over the Money from Your Employer-Provided HSA into Another HSA This strategy is similar to option 2. You contribute to your employer-provided HSA via payroll deduction, then roll over the money to an HSA provider of your choice. There are two key differences between a rollover and a transfer, however. The first is that in contrast to a transfer, where the two trustees handle the funds and leave you out of it, a rollover means you get a check for your balance; you must deposit that money into another HSA within 60 days or it counts as an early withdrawal and a 20% penalty will apply if you're not yet 65 (or if you don't have receipts to support medical expenses equal to the amount of your withdrawal). Another key difference is that multiple transfers are permitted between HSAs, but you're only allowed one HSA rollover per 12-month period.