Health Savings Accounts: Next Generation Retirement Savings Vehicles?Download the PDF
By Randy Myers
Could a savings account designed to cover medical costs actually be a good way to enhance retirement savings? In some ways, and under some circumstances, yes.
Health savings accounts, or HSAs, are tax-advantaged savings vehicles created to help people who are enrolled in high-deductible healthcare plans pay for out-of-pocket medical expenses. Currently, plans with annual deductibles of at least $1,300 for individuals or $2,600 for families count as high-deductible plans.
While aimed at helping Americans pay for medical expenses, Danny Humphrey, Vice President of Enterprise Sales for HealthEquity, an HSA administrator, notes that HSAs also can be used as long-term investment vehicles. Speaking at the 2016 SVIA Fall Forum, Humphrey observed that HSAs can offer even better tax benefits than traditional retirement accounts in some circumstances. While relatively few people use HSAs as investment vehicles today, Humphrey said, that is partly because many do not understand exactly what they are or how they work.
Authorized by Congressional legislation in 2003, HSAs often get confused with flexible spending accounts, or FSAs, simply because FSAs have been around longer. Like HSAs, FSAs also can be used to pay for out-of-pocket medical expenses. But the two accounts differ in how long money can remain in them. With an FSA, money typically must be used in the year it is contributed. With an HSA, contributions can stay in the account indefinitely, and can even be passed along to the account holder’s heirs.
HSAs offer multiple tax advantages. Contributions are made with pre-tax dollars. Interest and investment income are tax-free, and withdrawals also are tax-free if used for qualified medical expenses by the original account holder. This triple tax play can make an HSA a particularly attractive savings and investment vehicle, better, even, than a Roth IRA or Roth 401(k). Withdrawals from those accounts are not subject to federal income taxes, either, but contributions to those accounts are made with after-tax dollars. Only an HSA offers a tax benefit both at the time of contribution and the time of withdrawal.
There are a variety of ways investors can take advantage of HSAs. They can funnel money they otherwise might have put into a traditional retirement account into an HSA, and then use the HSA, rather than the traditional account, to pay for qualified medical expenses in retirement. Or they could continue to fund their retirement account in full, but supplement those savings with an HSA. Because account holders can reimburse themselves for medical expenses years after those expenses were incurred, assets in the HSA can grow tax-free for a long time, and the payoff can be substantial. A couple with a 30 percent tax rate, Humphrey noted, would have to save $370,000 in a traditional IRA or 401(k) to cover $260,000 in medical expenses in retirement, but only $260,000 in an HSA.
Individuals participating in high-deductible healthcare plans can contribute up to $3,400 to an HSA beginning in 2017, or up to $6,750 for a family. Contributions initially count as deposits and are typically held in an FDIC-insured savings account or some type of stable value fund. Once the cash portion of the account reaches $2,000, account holders can begin contributing to a separate investment account, where it can be steered into a wide range of securities, including stocks, bonds, mutual funds, and more.
Humphrey says HSAs are likely to become increasingly popular as more employers begin offering them, a trend he is already seeing among large employers. In 2010, Humphrey said, only 7.6 percent of large employers offered a high-deductible health plan as their only health plan option. By 2014, that percentage had risen to 17.8 percent, and by 2015 it was expected to reach 30 percent.
The use of HSAs is quickly inflating the amount of money held in HSA accounts. In 2010, HSAs held $9 billion in deposits and $900 million in investments. By 2015, deposits had grown to $26 billion and investments to $4.2 billion.
Humphrey is encouraging the HSA industry to do a better job of promoting the investment opportunities in HSA accounts. Unlike HealthEquity, he said, many HSA administrators outsource the investment portion of the business, do not make much money on that part of the business as a result, and so do not tend to promote it. Outsourcing also makes things more complicated for account holders, he argued. For example, it forces them to access their accounts through two different web portals, one run by their HSA administrator and the other by their investment manager.
This could change soon. When the Department of Labor issued a new rule earlier this year expanding the definition of a retirement plan fiduciary to include anyone offering investment advice to a plan or its participants, it specified that those rules apply not just to traditional retirement plans but also to HSA accounts. “The DOL rule,” Humphrey said, “will force a lot of players in this space to not outsource (investment management) anymore.”
If so, it could improve outcomes for account holders, at least judging by HealthEquity’s experience handling investment management internally. The average five-year balance in HSA accounts that HealthEquity administers, Humphrey said, is more than $4,700, or about double the industry average.