The Health Savings Account (HSA) is becoming increasingly popular as a retirement savings vehicle in the US. The new Biden presidency and the now Democrat controlled Congress are likely to accentuate this trend in 2021 and beyond.
According to Devenire, the research firm, HSA assets have grown about 10-fold over the past decade. There were 28m accounts with $66bn (€54bn) in funds at the end of 2019, and this figure could exceed $105bn by the end of 2021. That is quite a performance, considering that HSAs were created in 2003 and the annual maximum tax free contribution is only $3,600 for a single person, $7,200 for non-single (in 2021).
To qualify for an HSA, an individual must be covered by a high-deductible health plan and must not be enrolled in Medicare (public health insurance for people aged 65 and older). The HSA can be offered as a benefit by the employer to the employee or it can be opened by a self-employed worker. The money in the HSA can be used to pay for out-of-pocket qualifying medical expenses until the deductible is met.
One advantage is that individuals do not lose their contributions at the end of each plan year: the money keeps accumulating. Moreover, HSAs enjoy a triple tax advantage: contributions are pre-tax; the accumulated money can be invested and investment returns will not incur tax; when funds are used for qualified medical expenses, they are tax-free. Once the account owner reaches 65, distributions for qualifying medical expenses remain tax-free. Any other form of distribution is taxed like any retirement savings.
“If you have to pay for a $1,000 medical expense, you need about pre-tax $1,200 so with an HSA you save $200: that is the appeal of this instrument, very useful when you are retired and you are likely to spend more for health,” says Kevin McKechnie, the executive director & founder of American Banker Association Health Savings Account Council (ABA HSAC), the national association of banks, insurers and other providers of HSAs.
However, “employers and participants are only just coming to appreciate HSA power as an additional way to save for retirement,” says Jack Towarnicky, principal researcher for the American Retirement Association (ARA), analysing the second annual HSA benchmarking survey, published by the Plan Sponsor Council of America.
The survey received responses from 181 organisations that offer HSAs to employees: 51.5% of employers now position the HSA as a retirement savings vehicle; 61.3% of employees enrolled in the HSA-qualifying health option when given the opportunity; the average participant contribution in 2019 was $2,595, the same as in 2018 while the average account balance at the end of 2019 was up from a year ago, at $5,627. Most organisations (83.8%) offer investment options for HSA contributions but more than 80% do not try to mirror the HSA investment lineup with their 401(k) lineup.
“An individual will typically want to use a different investment strategy for their HSA and their 401k plan: in particular, the two accounts serve different purposes, and have significantly different liquidity provisions,” points out Towarnicky. “Most HSAs assets are held in capital preservation investments”.
There are hundreds of providers of HSAs: the largest one is Optum (UnitedHealth Group) with a 17% market share according to the latest Morningstar study of the industry. Fidelity is the fastest growing provider, with a market share of 10.5% as of mid-year 2020, up from 4.5% at the end of 2016: it also offers the best HSA with no fees to spenders and low charges for investors: a passive 60% equity/40% bond portfolio has an overall cost of 0.02% regardless of account balance.
The Morningstar study also shows overall, providers continued to improve on multiple fronts over the past year. Several HSAs have cut fees, improved investment menu designs, or lowered investment thresholds. The latter requires participants to maintain a minimum checking account balance before they can invest.
HSAs can grow further if employers offer matching contributions and adopt automatic enrollment for employees who choose high-deductible health plans, Towarnicky says.
Thanks to a petition to the Internal Revenue Service (the fiscal agency) by the ABA HSAC, telemedicine and other remote-case services are now “qualified medical expenses” that can be paid with an HSA.
“We asked that because of the COVID-19 crisis but we hope it will remain a permanent feature,” says McKechnie.
“We also hope to find bipartisan support in the new Congress for our proposals to use HSAs to pay for more kinds of medical practices, raise the limits to contributions, and allow people who get Medicare to keep contributing to their HSAs,” he says. “All this will increase the appeal of HSAs.”
McKechnie expects president Biden to back these changes because they will help strengthen the Affordable Care Act of 2010, signed into law when Biden was president Obama’s vice president.