The acceptance of tax-favored Health Savings Accounts (HSAs) continues to grow steadily. Last year, there were an estimated 21 million HSAs, almost twice as many as in 2013 (EBRI 2018). As more employers, employees and health insurers continue to gain knowledge and comfort with HSAs and the associated consumer-directed high deductible health plans (HDHPs), this trend should continue. One study projects that the number of HSAs will grow to almost 43 million by 2021(Aite Group LLC 2018).
This month, PLANSPONSOR magazine organized a conference cosponsored by Bank of America Merrill Lynch that examined those trends and, perhaps more importantly, considered ways that HSA utilization may be accelerated through education and legislation.
Tax-advantaged way to save for health care in retirement
When HSAs were first created in 2002, the primary objective was to encourage greater adoption of consumer-directed health plans which are intended to discourage the unnecessary health care utilization that can result from health plans that insulate consumers from the costs of health services. HSAs were designed to provide incentive for employees to become more cost-conscious consumers because they would be “spending their own money.” But there is a secondary benefit of HSAs that receives less attention—the ability to utilize the account’s tax advantages to set aside money today to cover future health expenses, including retiree health costs.
Today, a 65-year-old couple may require more than $400,000 to cover their future lifetime health care costs (Medicare Parts B and D, supplemental insurance premiums, dental premiums, and out-of-pocket expenses) (Health View Services 2017). And that estimate does not include potential nursing home and other long-term care costs. Most Americans have saved little to prepare for this impending liability and they do not realize that HSAs provide an extremely tax-efficient way to begin to address the staggering retiree health savings challenge. But the full advantage of the unique “triple tax advantage” of HSAs (pre-tax contributions, deferred tax on earnings, and tax-free qualified distributions)1 is only realized if contributions are left in the account and invested.
Unfortunately, the potential of HSAs as a retirement savings vehicle is grossly underutilized even by individuals who have HSAs. Today, most account holders think of their HSA balance as money to be spent now. Many who have had years of experience with “use it or lose it” flexible spending arrangements (FSAs) do not realize that they don’t have to spend down their HSA every year. Others do not have easy access to longer-term investment options within their HSA. The result is that only a very small percentage of HSAs are currently being invested to prepare for future health care needs.
But that may be changing as more employers are beginning to better understand that HSAs will best serve their employees if they are offered as an integral part of a coordinated health and retirement conversation. That is not an easy or simple process. But the tax advantages of HSAs dictate that they should be a part of any retirement planning strategy. Perhaps that is why 75% of employers view HSAs as part of their retirement benefits (PSCA 2017). Of course, everyone’s situation is different, but there are certainly many situations where an employee may be better off making an HSA contribution in lieu of maximizing their retirement plan or other savings contributions. The next step in the evolution of HSA utilization could be ensuring that coordinated HSA and retirement savings communications educate employees about the benefits of long-term savings in an HSA. Many employers have already started down that path.
The tax advantages of HSAs dictate that they should be a part of any retirement planning strategy.”
Changes to HSA rules
At the same time, efforts to improve the HSA rules to make them fairer, more efficient, and more effective have been ongoing. It should be expected that the lessons learned over the last 15 years would lead to a better understanding of how the rules could be improved, and some of those proposed changes were included in two bills that were recently passed in the House of Representatives. Those House-passed HSA changes fall into three broad categories:
Making HSAs and HDHPs More Flexible. A number of proposals are designed to increase the attractiveness of HSAs by making the HSA and HDHP requirements more flexible. These include allowing HDHPs to allow limited first dollar insurance coverage (up to $250 for individual coverage or $500 for family coverage) prior to the satisfaction of the plan’s minimum deductible. This amount would be in addition to currently required first dollar coverage for preventive services. Other changes would expand the definition of qualified medical expenses that are eligible for tax-free HSA distributions to include over-the-counter medicine, menstrual products, and certain gym memberships or exercise programs. In addition, the HSA rules would be modified to allow an individual to retain HSA eligibility even if: (1) they receive certain services, in connection with employment, at an on-site or retail clinic; (2) they participate in a direct primary care service arrangement (i.e., an arrangement under which an individual is provided access to primary care medical services under a fixed periodic fee); or (3) their spouse has a health FSA.
Expanding HSA Savings Opportunities and Eligibility. One important proposed change that could substantially enhance the HSA as a retiree health savings vehicle is a proposal to almost double the annual maximum HSA contribution. Another proposal would allow individuals who are eligible for Medicare by reason of reaching age 65 to continue to make HSA contributions if they maintain an eligible HDHP. This provision would mean that employees who continue working after attaining age 65 could stay in their HDHP at work and continue making HSA contributions.
Simplifying HSAs. Other changes would resolve technical glitches that have developed under the existing HSA rules. One such change would allow married spouses who are at least 55 years old to make catch-up contributions to the same HSA. Another proposal would permit an individual who establishes an HSA within 60 days of getting coverage under an HDHP to treat medical expenses incurred during that 60-day period as qualified medical expenses even though the expenses were incurred before the HSA was established.
Although many of the improvements in the HSA rules have a measure of bipartisan support, further Senate action on the comprehensive House-passed bills appears unlikely this year given the limited number of legislative days left in this Congress. It remains possible, however, that some of the narrower HSA proposals could be considered during the congressional lame duck session after the elections. In any event, when the new Congress convenes in January, the unresolved issues with the nation’s health care systems will once again move front and center. Improvements in HSAs will certainly be a part of that debate and, as the popularity of HSAs continues to increase, changes to improve the HSA rules are almost inevitable.
1 About Triple Tax Advantages: Participants can receive tax-free distributions from their HSA to pay or be reimbursed for qualified medical expenses they incur after they establish the HSA. If they receive distributions for other reasons, the amount withdrawn will be subject to income tax and may be subject to an additional 20% tax. Any interest or earnings on the assets in the account are tax free. Participants may be able to claim a tax deduction for contributions made to the HSA. We recommend that applicants and employers contact qualified tax or legal counsel before establishing an HSA.
Randy Hardock is a regular columnist for Workplace Insights focusing on legislative and regulatory matters affecting employee benefit plans. He is a partner in the Washington, D.C., law firm of Davis & Harman, LLP, having previously served as Benefits Tax Counsel at the Treasury Department and as Tax Counsel to the Senate Committee on Finance. The opinions expressed are Mr. Hardock’s and do not necessarily reflect the opinions of Bank of America Merrill Lynch. Davis & Harman, LLP is not an affiliate of Bank of America Corporation.