The Health Savings Account (HSAs) – A Planning Home Run?

November 10, 2021 – What if I told you I had a planning strategy, that would:

1. Address one of life’s major stressors,
2. Avoid the taxman,
3. Help your adult children, and
4. Provide for elder care costs

Hopefully you would say, “Sign Me Up”! I would like to introduce you to the Health Savings Account, the ‘HSA.”

Brief History

In the 1980s and 1990s, Congress began discussing Medical Savings Accounts (MSAs) where any consumer could (1) pay for all medical expenses with tax-deductible dollars and (2) spend or save unlimited tax-advantaged amounts for current or future medical expenses. First introduced in 2003, HSAs were created to incentivize saving for medical expenses for those in a high deductible plan.

HSAs offer the most significant tax benefits – more than any other retirement account, including a 401k. … With an HSA, you can tap into the power of triple-tax savings. This means contributions to your account are tax-free, earnings are tax-free, and withdrawals for eligible healthcare expenses are tax-free.

Healthcare Worries

In 2020, nearly one-third of American voters feared they wouldn’t be able to pay for health care costs, and nearly 80 percent of likely voters said they thought reducing health care costs should be a high priority for the next president.

Fast forward one year, about 66% of Americans report they are very, somewhat, or a little concerned they won’t be able to afford medical care this year. While the pandemic indeed impacted the two-fold increase in consumer concern, health care affordability continues to be a major issue in this country. Despite spending more than the other high-income countries on health care as a percentage of GDP, the U.S. still ranks last in health care performance.

Match Made In Heaven

Is the most tax-efficient investment vehicle addressing one of the most significant concerns of the American people (across all wealth categories), a HOME RUN?

It depends on your perspective. A recent report shows $17 billion already invested in HSAs, which is a 32% increase year-over-year from 2019 to the summer of 2020. The average balance of accounts is $15,000.

In comparison, as of June 30, 2021, 401(k) plans held an estimated $7.3 trillion in assets, with the average balance for participants in their 40’s of $36,000 and more than $300,000 for those participants in their 60’s.

HSAs are definitely catching on; and right now, let’s consider them a ground-rule double!

What’s Missing?

While the growth trajectory is positive, what factors might present obstacles to faster growth?

1. An essential benefit of a Health Savings Account is the ability to invest your account balance. However, financial institutions are reluctant to offer the account since managed assets are low and transaction volume is above average. In other words, the product is not very profitable! Without the promotion, few account holders even realize their balances can be invested. There’s a huge opportunity here because only about 5% of the accounts currently hold investments, with the rest representing non-interest-bearing cash balances.

• The consumer does not know the basics of how healthcare insurance works!  The health insurance knowledge gap goes beyond the pandemic to understanding basic health insurance plan features, and it is more prevalent among younger plan participants. In a recent survey, over half (51%) of 18–29-year-olds could not accurately define what a deductible is, and almost half (48%) couldn’t correctly define what a copay is. 

• The cost/benefit analysis is not easy to perform, and there are limited resources available to guide consumers on the appropriate decision! The IRS also has not done a good job of making them less complicated.  The uncertainty inherent in a prognosis for future healthcare needs clearly would bias a decision to not accept a high deductible plan. Coupled with the complexity of performing the analysis on an after-tax basis, the decision to “go with the highest benefit plan” seems rational and a good hedge despite the premium cost!

Popular Misconceptions

Let’s first address some of the basics of the Health Savings Account, which could dispose of some perceived myths.

• An HSA is money that is yours! Think of it just as you would your 401k or IRA. You can spend it on healthcare costs but do not have to.  There is no “use it or lose it” time limit as with Flexible Spending Accounts (FSA’s). Once you put the money in, it’s yours forever whether you switch out of the plan or leave the company. When you need it, it will always be there.
• To deposit money into a Health Savings Account, you must be enrolled in a high deductible healthcare plan (HDHP). If for any reason, you can no longer participate in an HDHP, you DO NOT have to spend down the funds in your HSA.
• You cannot contribute additional funds to an HSA if Medicare covers you.  However, if you are still working and participating in an HDHP, you can still make tax-effective contributions despite being Medicare eligible.
• Most participants will find their HSA via payroll deduction.  However, the account could be funded by a lump sum at any time before the April 15^th tax filing date. For 2021, the contribution limits are $3,600 for individual coverage and $7,200 for family coverage. If you’re 55 or older- not 50- you get an additional $1,000 catch-up contribution per person. The big thing to know here is that if two spouses over the age of 55 are on the same plan, the second spouse needs to open their own HSA to contribute $1,000.

Advanced Facts & HSA Strategies

Now that I have gotten your attention about the benefits of using an HSA, let me provide you with some ideas on stretching that double into a home run!

1. The financial principle of “compounding” is probably the single most determinant factor in growing wealth. Just follow the Golden Rule- “Start early, save the maximum, avoid tax and invest wisely.” A 25-year-old couple saving $7,200 /year and investing it for an average return of 6% will have set aside $1.1 million at age 65, which could be used for various medical costs experienced in later years. The problem of funding long-term care issolved!
2. For many reading this article, the “save at age 25” ship has sailed. Changing the facts a bit, starting at age 55, a couple contributing the maximum until age 67 and continuing to invest at 6% would have a medical “nest egg” of $300,000 at age 75.
3. Let me address the following question I’m sure you have, one that is crucial to your decision. “How the heck can I afford to save the maximum amount and not use the funds to pay current medical costs?” My self-saving answer is, “How can you afford not to?” It will take some “brainpower” and concentration to determine a funding solution, but here’s how:
   • Stay healthy and be a conscious consumer of healthcare. Your decisions can effectively manage healthcare costs. Maintain an annual healthcare plan.
   • Adjust your 401k/403b funding strategy (please tell me you are saving for retirement). Fund these plans up to the amount that your employer will match. Then, fund your HSA with the maximum allowable amount. And unlike 401k contributions, which are only deductible for federal and state income tax purposes, HSA contributions also escape Social Security and Medicare tax.
   • An HSA requires selecting a high deductible plan, which in turn has a lower premium cost but higher out-of-pocket limits than non- HDHP’s. Now, “do the math.” Start with your best estimate of your annual health care costs, which is part of your annual plan. Sure, anything can happen, but statistically, it doesn’t. Now, take out your calculator and calculate the difference in premium costs for the HDHP and Non-HDHP. That represents premium cost savings. Next, compare the maximum out-of-pocket costs between the two plans. This represents your healthcare cost risk. Subtract the risk amount from the savings amount. I often find that the “net risk” amount is not significant, and, in some cases, when your estimated annual healthcare costs are below the maximum out-of-pocket limit, you have additional savings. Set the money aside and treat yourself at the end of the year with any money left over!
4. Many of our clients express a desire to retire early but refrain from doing so because of the cost of private health insurance for post-employment and pre-Medicare eligibility. An HSA can help fund this gap at a critical phase of life!
5. When you finally get to your “golden years,” the benefits keep on coming:
   • You can pay Medicare premiums with HSA funds as well as long-term care insurance premiums.
   • The list of eligible medical costs is long and keeps growing.  An HSA could be used for hearing aids, dental & vision costs, and health-related improvements to your home.
   • You can spend your HSA dollars on any tax dependent, including care for aging parents who may have moved in with you.
   • Many retirees must tap their IRAs for unexpected medical costs. Using your HSA prevents you from taking IRA distributions that are taxable (bad enough) and affects the taxable amount of your social security benefits and the premium cost of Medicare Part B and Part D. This is a very effective tax strategy to manage your income tax brackets in later years.

Thinking About Your Legacy

With thoughtful planning, you could utilize Health Savings Accounts to help your children and grandchildren.

When working with clients’ children who are starting their careers, we often suggest they stay on their parent’s medical plan, which is allowed until age 26.  While the children are not allowed to use their parent’s HSA, they can open their own, and because a family HDHP covers them, they can contribute $7,200 to their HSA account. Forward-thinking parents sometimes are willing to help their children fund the contribution. While the tax savings benefit the child, parents canprovide an initial “medical nest egg” approaching $50,000 per child to benefit future generations.

There is no real-time limit to using your Health Savings Account. And there is no requirement that the withdrawal of funds be in the same year that the medical costs were incurred. You could be incurring medical costs for 40 years, and as long as you keep the receipts, you can reimburse yourself for those costs AT ANY TIME. Imagine 40 years of pre-tax contributions, tax-free growth, and non-taxable distributions.  If you could not document initial medical costs or do not expect future costs to utilize the balance fully, you can withdraw the funds without penalty once you reach 65. You will have to pay tax, but a small price to pay after many years of tax deferment. It can be used like  distributions from an IRA to manage your tax bracket but has the advantage of not having a required distribution.

If you pass away with a balance in your HSA, your spouse would inherit the balance and be able to use it for his/her benefit. Inheritance by a non-spouse would require immediate liquidation, and proceeds would be subject to tax (no penalty).

CONCLUSION

I recently wrote an article, Healthcare Planning- a Missing Piece (https://rscapital.com/2021/09/29/healthcare-planning-a-missing-piece/) which provides a broad perspective of the importance of healthcare planning during your lifetime. This overview of the Health Savings Account is one of many planning opportunities available to those seeking an optimal life and Financial Life Guides who help clients achieve one.

If you or anyone you know is interested in learning more about HSAs specifically or are intrigued by the concept of Healthcare Planning more broadly, please reach out to us.