The Benefits of a Health Savings Account Today and Tomorrow - Part 1

Health Savings Accounts provide both immediate and long-term financial benefits to owners who understand and harness their power.

Oct. 15 is the fourth annual HSA Day. Since it falls midway between HSA Wednesday Wisdom publication dates, we'll divide the benefits of a Health Savings Account between today (today's column) and tomorrow (next week's).

Health Savings Accounts are a powerful financial ally. But the benefits - like those of other tools - are limited to those who understand how to harness the power of these accounts. HSA Day was created in 2019 to help average Americans understand how to extract the most value from this opportunity. Since then, Americans have opened eight million new accounts (a 30% growth rate) and grown their balances by about $35 billion (more than a 50% increase). Growth in the future will only continue as companies and workers look for more effective ways of covering medical expenses.

Let's look at some of the ways that Health Savings Accounts deliver value today.

Ability to Mitigate or Manage Other Risk

Too often during open enrollment, employees look at their employer benefits in a silo. They typically either affirm their in-force coverage, spend a few minutes reviewing their options, or do nothing and are defaulted into their current plan. That's too bad, especially when they choose based on the difference in deductible or out-of-pocket cost among the competing plans.

A better approach is to look at benefits as a whole, with an eye toward managing individual risk. A generally health employee (and family, if applicable) may be better off financially by redistributing their employer dollars across a wide range of products by reducing their medical premiums (in exchange for higher out-of-pocket costs that they typically don't pay every year) and allocating the savings to some combination of a Health Savings Account, voluntary coverage (like hospital indemnity, accident, and critical-illness coverage), and other products (like additional life or disability insurance, or even pet insurance).

HSA-qualified plans usually have the lowest payroll deductions. That extra $20 or $50 or even $75 per paycheck can buy a lot of other protection. Of course, in some situations, the employee's best option is to spend the bulk of her employer benefits dollars on reducing the out-of-pocket responsibility on her medical plan. But often that's not the case. Until you sit down and do the math, you won't know.

This exercise is easier now with the introduction of decision-support tools that go beyond comparing medical plans to allocating benefits dollars across the full range of coverage offered to minimize personal risk. Imagine s pending an hour allocating those funds optimally and buying an additional $1,000 of protection against other financial losses besides medical. That's a great outcome. But this form of loss-mitigation is available to only those who take the time to look at their personal situation and are flexible enough to follow the math.

No federal or state taxes

Like contribution to tax-deferred retirement accounts, Health Savings Account deposits aren't included in taxable income when calculating federal or state (except in California and New Jersey) income taxes. For many taxpayers, that's a savings of 22% to 24% in federal income taxes alone, plus an average of about 5% for those whose states impose an income tax. Right off the top, the savings are 25% or more.

What does that mean? For every $100 that you contribute to your account, your paycheck doesn't decline by the full $100. Rather, you'll see perhaps a $70 to $78 drop in take-home pay. But the full $100 goes directly into your Health Savings Account to spend tax-free on qualified medical, dental, and vision services, plus over-the-counter drugs, medicine, equipment and supplies, plus certain insurance premiums.

No Payroll Taxes

Health Savings Accounts have an added benefit over tax-deferred retirement accounts: Federal payroll taxes don't apply to contributions. That's right, the 7.65% federal payroll tax (1.45% for those who earn more than $147,000 annually) is not applied to pre-tax pay roll deposits. This tax break means that you keep more of your income to pay for qualified expenses.

Add the payroll tax savings to the reduction in federal and state income taxes, and many Health Savings Account owners are saving 30% or more in taxes. That means that balances are growing about 30% faster, or it takes about 30% less income, than deposits into an emergency savings account.

An Emergency Account

Surveys show that most Americans don't have $1,000 cash in a savings account to cover an unexpected expense like a furnace repair or a trip to visit a sick relative. Putting the expense on a credit card may relieve the immediate cash crunch, but then the card statement arrives and interest of 20% or more is applied. In many cases - and we saw this situation become even more common during the pandemic phase of Covid-19 - people paid those bills via a withdrawal from their only source of savings: their retirement account. In doing so, they incurred multiple financial setbacks:

• The withdrawals were usually included in taxable income.
• An additional tax may have been applied as a penalty for a premature withdrawal (though legislation later modified this penalty).
• They withdraw funds that otherwise would have compounded until withdrawal in retirement, thus reducing their spending power later in life.

In contrast, Health Savings Account owners who had built balances over time (the average account owner - though individual situations varied widely - had contributions that exceeded distributions of about $420 a year during the last decade. Thus, the average experienced owner had built a balance to pay an unexpected bill for a qualified expense with no taxes or penalties without straining the family budget or, in effect, borrowing against her future.

Flexibility to Adjust Contributions

Health Savings Account owners aren't locked into an annual election. They can change their contribution level - start, stop, increase, or decrease - as their needs change. This feature is in marked contrast to a Health FSA, which offers similar tax benefits but requires a binding annual funding commitment that can be altered only with a limited range of qualifying life events.

This flexibility is welcome news to anyone who's ever made an election to a Health FSA, only to learn that she needed to replace a dental crown or that she was no longer a candidate for the vision-correction surgery for which she elected her maximum contribution. It allows owners to adjust when their projection of spending on qualified items during the year doesn't match their experience as the year unfolds.

The Bottom Line

Health Savings Accounts deliver value. If your employer offers a program and you haven't enrolled, it makes sense to consider whether this approach delivers greater financial benefit to you. The Health Savings Account program and the extra money that you can allocate to other forms of financial protection may not be the best allocation of your benefits dollars. But you'll never know if you don't take the time to understand your personal situation and look objectively at how to spend your annual allotment of employer benefits dollars.

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