The Deal With Health Savings Accounts

Over the past few years, an inordinate number of articles have been written in the investment/financial media about the value of health savings accounts as investment vehicles. This seems to make little sense, for two reasons. First, estimates vary, but somewhere between 5% and 15% of assets in HSAs are now actually being invested, as compared to the 85% to 95% of assets that are held in money-marketlike cash accounts. Second, the annual contribution limits for HSAs--for both individuals and families--are relatively low.

Is there a business opportunity for advisors to charge into the HSA marketplace when the bulk of assets in HSAs are not being invested, and when what can be contributed annually is still a fairly small amount?

Advisors are in the enviable catbird's seat to provide education, information, and advice to HSA holders should they choose to. Before getting into that discussion, though, let's review the HSA and its many advantages.

An HSA is an individually owned custodial trust account that an employer may offer to its employees, but only if it also offers a qualifying high deductible health insurance plan. No high deductible plan, no HSA. Even when an employer does offer one of the plans, employees become eligible to contribute to an HSA only when the plan provides (in 2018 numbers) for a minimum deductible of $1,350 for an individual and a maximum out-of-pocket cap of $6,650; for families, the minimum is $2,700 with an out-of-pocket cap of $13,300.

In 2018, eligible employees can contribute up to $3,450 annually to an HSA for an individual and $6,900 for a family. Employees 55 and older can contribute an additional $1,000 annually. (Employers can help contribute up to these limits, too).

At first blush, these relatively small contribution numbers--even lower than the annual contribution limits for IRAs--may not be particularly attractive to advisors looking for an additional line of business and a way to further diversify their revenue sources.

The numbers look better, though, on closer inspection. For example, the total amount of contributions that could've been made by an individual younger than 55 for the entire 14-year period (2004 to 2017) during which HSAs have been in existence is $42,550. A 6% annual compounding rate lifts that account balance to $66,354 after 14 years, and an 8% rate yields $77,402.

Further, there's a provision in the tax reform legislation pending in Congress to expand the advantages of HSAs. Reforms could double the HSA contribution limits to $6,900 for an individual and $13,800 for a family while also providing a $1,000 catch-up contribution for each spouse beginning at age 55 (as under current law). Other enhancements might include reducing from 20% to 10% the penalty on payments made for nonqualified medical expenses, broadening the definitions concerning qualified medical expenses, and allowing individuals currently enrolled in Medicare to contribute to an HSA. (Under current law, when individuals enroll in Medicare, they must stop contributing to their HSAs).

If these new limits become law, some HSA holders could be within striking distance of being able to pay for the estimated $250,000 to $400,000 in medical expenses they may very well incur in retirement, depending on the number of years that they maximize their contributions (including the extra $1,000 for those 55 or older).

For example, a family contributing $6,000 annually to an HSA compounding at 6% for 20 years would have nearly $250,000 by retirement. Doubling annual contribution limits for both families and individuals could boost accumulated HSA balances even higher.

Any such computations assume, of course, that HSA contributions are maximized, that they are invested, that they are left alone to grow tax-free, and that the account holder is able to pay for medical expenses out-of-pocket. No doubt that last assumption is a tall order for many employees, especially those with families.

Nonetheless, advisors are in a great position to educate and inform employees participating in high deductible healthcare plans about these very real--and achievable--opportunities to accumulate tax-free money to pay for medical expenses in retirement.

A tip for advisors when educating/informing/advising employees about paying medical expenses out-of-pocket: Employees should always ask their doctors what the "cash payment price" (or some other similar term) is to pay for their treatments. In my own neck of the woods, I'm often offered a 40% discount off the doctor's bill; in effect, the cash payment price is the amount a doctor is willing to pay to avoid the hassle of having to deal with billing my insurance company. It's tough enough for an employee (especially one with a family) to pay for medical expenses out-of-pocket in order to leave untouched the balance in its HSA and maximize its growth, all in the name of being able to cover all (or at least a good amount of) medical expenses in retirement. But that task becomes easier when such payments can be reduced by 40% or more.

The trifecta of advantages offered by HSAs that is trumpeted in headlines, of course, is what makes them so perfectly attractive: money in (contributions) is tax deductible, money growth is untaxed, and money out (distributions) is both untaxed and nonpenalized. Such a deal! But, alas, one with some qualifications that follow.

First, any contributions made by an employee (or in conjunction with its employer for the employer's own contributions on behalf of the employee) to an HSA are income tax deductible for the year in which they're made (just like contributions, say, to a 401(k) plan). Second, such contributions which will (hopefully) grow over time do so on a tax-deferred basis (again, just like contributions to a 401(k) plan). Third, account holders in retirement (at age 65 and older) using their HSA balances to pay for qualified medical expenses will incur no taxes or 20% penalty (unlike distributions from a 401(k) plan); even if the retired account holders use the balance to pay for nonqualified medical expenses, they will incur no penalty although they will have to pay taxes.

HSA balances can be used to pay for healthcare services, equipment, or medications (as defined under Section 213(d) of the Internal Revenue Code) for an HSA holder, its spouse or its tax dependents. More particularly, this includes prescription drugs, limited health insurance premiums, COBRA continuation premiums, dental expenses, vision care expenses, a portion of qualified long-term care insurance premiums, healthcare while receiving unemployment compensation, plus any co-pays, deductibles, and co-insurance amounts.

However, HSA balances cannot be used to pay for over-the-counter drugs or some health insurance premiums (co-pays). Nor, in retirement, can they be used to pay for supplemental (Medicare) "Medigap" insurance premiums or Medicare Part B premiums.

HSAs are not subject to the age 70 1/2 minimum distribution requirements like 401(k) and IRA accounts are. Given that, HSAs are a more tax-efficient way to pay for qualified medical expenses in retirement than taking a distribution from a 401(k) or an IRA account, paying taxes on it, and then using the net to pay for such expenses.

HSAs have grown significantly in popularity since their introduction 14 years ago. By year end 2018, consulting firm Devenir estimates that the HSA marketplace will likely exceed $54 billion in assets and encompass nearly 30 million accounts.

Next month's column will answer how advisors can charge into the HSA marketplace to gather assets and invest and manage those assets.