Viewpoint: HSAs Build Long-Term Wealth with Tax-Favored Savings (November 2013)

By Dennis Triplett, UMB Healthcare Services

Most people don’t realize that health savings accounts (HSAs) are one of the best long-term savings vehicles in the market today. Paired with high-deductible health plans, HSAs are available to help pay for current qualified medical expenses as well as to save for future expenses, all in a tax-exempt account.

Many consumers continue to use their HSA the same way they use their flexible spending account (FSA)—using available funds for current expenses. While that’s an option with HSAs, it’s not a requirement as the “use or lose it” rule doesn’t apply with these accounts, and deposited funds are able to grow year-over-year, unlike FSAs. It’s easy to understand where the confusion comes from as HSAs are still new to many consumers and are often overlooked in benefits education and communications.

We believe there’s a great need for employers to educate themselves—and employees—about all that HSAs can offer beyond paying for the current year’s medical expenses. HSAs can serve as a powerful tool for long-term savings and as a key part of an overall retirement strategy to build wealth for both medical and other general retirement expenses, including tax-free Medicare premiums. Issuers or program managers that focus marketing efforts on the savings that can be achieved through HSAs could increase account take-up and improve the profitability for those accounts at the same time.

Building Wealth in an HSA

Even though HSAs are designed to pay current and future medical costs, only a handful of people fully grasp the opportunity to provide for future needs. Our 2012 study of more than 300,000 HSA holders showed an average deposit balance of just $1,440. Nearly 32 percent of UMB account holders have increased their balances and are saving more; however they are not coming even close to the maximum contribution allowed each year.

At that rate, most people are short-changing their futures. The IRS allows a maximum HSA contribution of $3,250 for individuals¹ or $6,450 for family¹ coverage in 2013 (plus a catch-up amount of $1,000 more for people over 55 years old). Those figures will rise modestly in 2014 to $3,300 for individuals and $6,550 for family coverage.

Less than 5 percent of the HSA holders we studied “maxed out” their allowable contributions.

Yet medical costs loom as a major financial burden for retirees. Industry estimates vary, but Fidelity’s widely recognized annual study shows an average healthy couple retiring in 2013 at age 65 will need $220,000 for out-of-pocket health care costs (after Medicare and not including long-term care costs).

Consider the potential on the upside: If a 40-year-old employee earning $80,000 today makes maximum HSA contributions, assuming a 5 percent return, the HSA alone will have more than $306,000 by age 65—enough to cover that average retired couple’s health expenses.

Note: This is a hypothetical example of compounding returns over time and is not intended to represent any particular investment or savings vehicle. The rates of return are constant nominal rates, compounded monthly. Actual investments will fluctuate in value. Contributions are assumed to be made at the beginning of the month. It does not take into consideration taxes or other applicable deductions, which will lower returns.

Of course, an earlier start adds more to savings, and delays limit the amount of the nest egg. And long-term returns vary. The point is, every employee faces the prospect of large medical costs in the future—and every employee, to prepare for those needs, should start saving now.

Gaining Triple Tax Advantages

Employees should always first take advantage of any offered match for their HSA or 401(k). After that, it can be a confusing task selecting where to invest remaining funds with the many types of accounts available. While many further invest in their 401(k)s or IRAs, their HSA actually is a better option in terms of flexibility, tax advantages and long-term growth potential.

The comparison chart below illustrates the key tax considerations for each type of account.

* Note: States can choose to follow the federal tax-treatment guidelines for HSAs or establish their own; some states tax HSA contributions. If you have questions about your tax implications, consult your tax adviser.

** Not taxed if funds are withdrawn for qualified medical expenses.

Taxes are an important consideration in long-term investing because of the compounding of savings. HSAs have the potential to offer triple tax advantages for individuals—something not seen in other retirement accounts. Only an HSA offers tax benefits at deposit*, during the account’s life and upon withdrawal. So a person saving for future medical needs can avoid taxes at all three stages in this life cycle.

Investing for Long-Term Growth

Major HSA providers now offer multiple investment options, including money market funds², self-directed accounts³ for mutual funds or individual stocks, and FDIC-insured accounts for cash needs. Yet only around 1 percent of the HSA holders we studied used the available investment options.

Employers should find an HSA plan that encourages long-term savings, including:

• Robust investment options—including dozens or hundreds of no-load or load waived mutual funds, capabilities for investing in equities, as well as bank and money market options.³
• Proactive educational approach—communicating with employees on how HSAs work both to pay near-term medical costs and to bolster a long-term retirement plan.
• Integration with other benefits—offering tools to help employees plan for the future, including investment objectives, risk tolerance and mix of assets across all accounts.

Today, most act as if the “S” in HSA stands for spending rather than savings. We have the opportunity to educate employees about the benefits of saving with an HSA, including preparing for future health care expenses during retirement or later in life.

Dennis Triplett is CEO of UMB Healthcare Services, a division of UMB Financial Corporation, which delivers healthcare payment solutions, including custodial services for health savings accounts (HSAs) and private-label, multipurpose debit cards to insurance carriers, third-party administrators, software companies, employers and financial institutions. He can be reached at [email protected].

In Viewpoints, prepaid and emerging payment professionals share their perspectives on the industry. Paybefore endeavors to present many points of view to offer readers new insights and information. The opinions expressed in Viewpoints are not necessarily those of Paybefore. If you’re interested in contributing to Viewpoints, contact Loraine DeBonis.

¹All mention of taxes is made in reference to federal tax law. Please check with your state’s tax laws to determine the tax treatment of HSA contributions, or consult your tax adviser. Neither UMB Bank n.a., its parent, subsidiaries nor affiliates are engaged in rendering tax advice. You may be eligible for additional tax savings if your employer offers a cafeteria plan and allows HSA contributions via payroll deductions. Please contact your employer for more information. Contributions are subject to annual limits established by the IRS. Payments and withdrawals not made for qualified medical expenses are subject to taxes and penalties.

²A peg balance (currently $1,000) is set to determine the amount of money that moves in and out of the money market mutual fund. Funds in your HSA up to the $1,000 peg balance, are a deposit in an FDIC-insured account. Funds in excess of $1,000 are an investment in a money market mutual fund that is not insured by the FDIC or any other governmental agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

³ Investments you make through your HSA are not FDIC insured. Securities offered through UMB Financial Services Inc., member FINRA (www.finra.org), SIPC (www.sipc.com). UMB Financial Services Inc. is a subsidiary of UMB Bank, n.a. UMB Bank, n.a. is a wholly owned subsidiary of UMB Financial Corporation. UMB Financial Services Inc. is not a bank and is separate from UMB Bank, n.a. and other banks.

Investments in securities, whether through the money market sweep account or through investments in the self-directed brokerage account are not FDIC insured, may lose value and have no bank guarantee.