Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

In one of the biggest changes to employee benefits in decades, high-deductible healthcare plans are appearing on more and more benefits menus, and these plans are experiencing dramatic growth in enrollment as a result. Just 2% of employers offered HDHPs in 2002; by 2014, three fourths of employers were offering such plans. Twenty-four percent of workers were covered by a HDHP in 2015, according to data from the Kaiser Family Foundation; 10 years ago, just 4% of workers were covered by an HDHP.

For some employees, the decision to participate in an HDHP is a choice; it appears alongside a traditional healthcare insurance plan like a preferred provider organization. But for an increasing share of employees, the HDHP is the only game in town: In 2015, for example, nearly a third of all employers offered it as the sole health-insurance option.

Yet despite their rapid uptake—or perhaps more aptly, because of it—there is widespread confusion about how HDHPs work, and how best to use the health-savings accounts that are typically offered in conjunction with them. According to research from HelloWallet, now a Morningstar company, many HSA owners fail to take maximum advantage of their HSAs. More affluent employees, in particular, are foregoing valuable tax benefits by not steering their HSA balances toward long-term investments. And even employees who are using a “spend as they go” approach to their HSAs should consider using the accounts to take advantage of the tax breaks. If you have foregone the HDHP/HSA combo in the past, use open-enrollment season for employee benefits to revisit it.

HDHP/HSA Basics
The parameters for what constitutes a high-deductible healthcare plan are a moving target; for 2016 and 2017, plans with annual deductibles of at least $1,300 for individuals and $2,600 for families are classified as high-deductible. There is also a cap on allowable out-of-pocket expenses for people insured under HDHPs; in 2017, as in 2016, the out-of-pocket maximum for HDHP plans is $6,550 for single coverage and $13,100 for family coverage. Note that these out-of-pocket maximums are a bit higher for people who obtain healthcare coverage under the Affordable Care Act; the preceding out-of-pocket maximums apply to employer-based plans. These maximum out-of-pocket expenses do not take premiums into account; it is worth noting that some plans’ out-of-pocket maximums are lower than the legal ceiling.

Employees covered by HDHPs are also allowed to contribute to a health-savings account; three tax breaks serve as an incentive to do so, and make the HSA the most tax-friendly savings wrapper in the tax code. HSA contributions consist of pretax dollars (or they are deductible, for people who are not using payroll deductions to fund their HSAs), any interest earned on the account is tax-free, and withdrawals for qualified healthcare expenses are also tax-free. Companies may also contribute to the HSA on behalf of their employees. Contribution limits for HSAs are going up a hair in 2017; next year, people with single coverage will be able to contribute as much as $3,400 to an HSA ($50 more than in 2016) and people with family coverage can steer $6,750 to their HSAs (the same as in 2016). People older than 55 can make an additional “catchup” contribution of $1,000 annually. Note that HSAs are different from flexible spending arrangements. While a use-it-or-lose-it policy (with a little wiggle room) applies to FSA balances, amounts in an HSA roll over from year to year; unused amounts in an HSA can build up and may be invested in long-term assets.

The Math Adds Up
The ability to roll over an HSA balance from one year to the next—as well as these accounts’ prodigious tax breaks—points to the fact that there is more than one way to use an HSA. The obvious usage is to spend from the HSA to cover out-of-pocket costs as they are incurred; because the contributions are pretax and qualified withdrawals are tax-free, it is far better to stake at least as much in the HSA as you expect to incur in out-of-pocket expenses each year. Unfortunately, the HelloWallet/Morningstar data suggest that many HSA contributors are not putting in enough to cover their out-of-pocket health expenses; the mean deferral amount in HelloWallet’s research was nearly $1,600 and the median was just $700.

The other way to use an HSA is to contribute to the account but use non-HSA assets to cover actual healthcare costs; that enables the money in the HSA to be invested in long-term investments and stretches out the tax benefits that the HSA wrapper affords. Using a basic example that compares investing in an HSA up to the annual limit versus investing the same amount in a taxable account, and earning an annualized 4% return over 30 years, the HSA investor would be $100,000 ahead of the taxable investor. That makes an annual HSA investment up to the limit pretty close to (but not entirely) a no-brainer for higher-income folks who are maxing out other tax-sheltered options like IRAs and 401(k)s. In my simplified example, detailed here, the HSA investor even comes out ahead of an investor who invested the same amount and earned the same return within a 401(k).

Safety Valves
Despite the potential for tax savings and improved take-home returns, the HelloWallet research shows that very few people use their HSAs as long-term investment vehicles; just 4% of the HSA holders in the sample group were using their HSAs in this way. Many HSA owners obviously do not have the financial wherewithal to both spend out of pocket for healthcare while also reserving their HSAs for long-term investments. And even HSA owners who do have the liquid after-tax assets to cover healthcare costs out of pocket may choose to spend from their HSAs instead, in an effort to keep healthcare expenses from throwing them off their budgets. Finally, there is the reality that it is early days for HSAs, and many of these accounts are larded with costs, both for the “spenders” and the “savers” who use them.

Yet there are ways to work around those impediments, as discussed in this article. People who would like to use their HSA as a long-term investment vehicle but are not sure if they can swing it long term can pay for their healthcare expenditures from their after-tax pockets as they are able. If they need funds at a later date for another, non-healthcare-related purpose, they can tap the HSA, provided they have saved the receipts for the healthcare expenditures they covered with non-HSA funds.

It is also worth noting that if you do not like your employer-based HSA, you can set up another HSA alongside of it and periodically (or annually) transfer funds from the employer-based HSA into your own, hand-selected HSA. That is a way to take advantage of the tax benefits and the convenience of having your HSA contributions extracted directly from your paycheck, while also maximizing your investment opportunities.

 

©Morningstar 2016. All Rights Reserved. Used with permission.