Will health savings accounts be the new 401(k)?
Boosters of health savings accounts (HSAs) in the financial services industry and in the U.S. Congress think so. They argue that the tax advantages of health savings accounts (HSAs) make them a superior option for saving - especially to cover the rising cost of healthcare in retirement. And expansion of access to HSAs and contribution limits have been a centerpiece of most Republican health reform plans ricocheting around Washington this year.
But a new report suggests that most HSA offerings are not yet ready for prime time. Morningstar, which pioneered independent grading of mutual funds, evaluated 10 popular HSA platforms both as spending accounts and as investment vehicles. The report gave passing marks for both spending and investing to just one of the 10, "suggesting there is much room for improvement across the industry.”
That is a polite, glass-half-full description. If HSAs are to play a major role financing healthcare, they will need to be more robust and less expensive - and more transparent to consumers shopping for the best deals.
HSAs are available to workers who have high-deductible health insurance. The accounts can be used to meet deductible and other out-of-pocket healthcare costs. This year, plans can have a maximum out-of-pocket cost of $6,550 for individuals, and $13,100 for families. Last year, 26 percent of employers helped offset those costs with contributions to the accounts averaging $868, according to Devenir, a consulting firm that works with HSA providers and employers. Workers also can make pretax contributions - this year, up to a combined total of $3,400 for individuals, and $6,750 for workers with family insurance coverage.
High-deductible plans are spreading quickly in the workplace, driven by the idea that more “skin in the game” will put a lid on healthcare costs by reducing wasteful use of healthcare services.
This is a proposition in search of evidence; research by the Employee Benefit Research Institute (EBRI) suggests that people in high-deductible plans actually reduce their use of both unnecessary and necessary services, and the decline in utilization is twice as large among lower-income workers.
Morningstar evaluated HSA spending accounts for monthly maintenance fees and interest rates. While interest rates are negligible across the board in the current low-rate environment, the researchers found that maintenance fees vary “wildly” among providers - and concluded that the differences can have a major impact on net wealth at retirement.
On the investing side, Morningstar concluded that most of the plans’ investment menus did a good job of offering exposure to core asset classes, but the industry did not receive passing grades on fees - one of the most important predictors of long-term performance. The HSA platform fees ranged “from cheap to expensive.” While some use low-cost index funds, others are using active strategies that lead to much higher total expense ratios.
Greater Transparency Needed
This is the first independent study attempting to grade the quality of HSA accounts. In fact, Morningstar finds a lack of transparency is one of the industry’s key issues. Workers with high-deductible insurance plans can shop among any of the HSA account providers, not just the one offered through their employers.
But it is not easy to shop, said Leo Acheson, Morningstar’s lead research analyst for health savings accounts. “Sometimes it’s difficult to discover what the investment lineup will be, and the fees - shopping can definitely be a challenge.”
Devenir publishes an online directory, HSA Search (bit.ly/2tdUVaX), which lets consumers shop for providers, but information on fund lineups and fees is not always available.
Eric Remjeske, Devenir’s president, notes that the industry is fragmented, with hundreds of players ranging from community banks to credit unions and large financial services institutions. “We work with most of the providers that do have transparency about their investment lineups, but not all of them make it available,” he said.
HSAs are offered only to workers enrolled in high-deductible health insurance plans (this year, these plans can have a maximum out-of-pocket cost of $6,550 for individuals, and $13,100 for families). The accounts are used primarily to meet deductible costs; employers often contribute and workers can make pretax contributions - this year, up to a combined total of $3,400 for individuals, and $6,750 for workers with family insurance coverage.
But contributions that are not needed to meet current expenses can be invested and spent later, tax-free, to meet healthcare expenses. The tax advantage is threefold: account holders can contribute untaxed income, avoid taxes on capital gains and dividends as contributed amounts grow, and then spend withdrawn sums tax-free on qualified medical expenses.
Very few HSA account holders are investing - 96 percent have their funds in cash, according to EBRI. But the invested amounts have been growing. At the end of 2016, some 15 percent of all HSA assets were invested, compared with just 8 percent in 2011, according to research by Devenir.
“You can’t deny tax advantages,” said Morningstar's Acheson. "Arguably, it’s the most favorable treatment anywhere in the tax code. And if you think the chances are good that you will have substantial healthcare costs in retirement, it’s an effective strategy to consider.”