Who Are the Investors among HSA Owners? And Are Enough Investing?

The latest edition of the industry's most comprehensive regular survey of activity provides insight into Health Savings Account investments.

Health Savings Accounts are an ideal vehicle for long-term savings and investment. They're the only account whose owners can escape federal income and payroll taxes and state income taxes (except in California and New Jersey) on contributions, investment gains, and withdrawals.

Yet industry surveys show that fewer than one in 10 Health Savings Accounts includes any active investments in mutual funds, stocks, bonds, and other instruments. That figure appears at first glance to represent a lost opportunity. But a more careful analysis of the situation, including a deeper dive into the latest edition of the industry's most comprehensive report, adds a few layers of understanding to the state of Health Savings Account investments. In fact, among accounts with sufficient balances to sink into equities, the investment rate in high. And the key factor in increasing that figure isn't so much to convince current owners with high balances to invest as it is to create more high-balance owners.

Account Balances

The average Health Savings Account has a balance of $3,000, up 29% from $2,300 at the end of 2019, the last report before the pandemic began. That a compound growth rate of about 14% annually. Most Health Savings Account trustees and administrators set a minimum cash balance of $1,000 to $2,000 before an account owner can invest the remaining balances. At an average account balance of $3,000, it appears that all owners have met the threshold. But that conclusion would be wrong.

Funny thing about averages - they don't tell the whole story, and they can be very misleading.

Example: A baseball team's starting rotation has an earned-run average (ERA) of 3 runs per nine innings, or 3.00. That performance would typically lead the league. But the top two pitchers have ERAs under 2.00 and the other three sit at 4.50. Now imagine the team enters the playoffs. A team with a 3.00 ERA has a high probability of winning that series. But let's say it's a best-of-five series and the starting pitchers lined up to start the first three games are the 4.50 ERA guys. Do you like the squad's chances now? Are this team's odds the same as one with a 3.50 ERA in which each pitcher's ERA is between 3.25 and 3.75?

Here are the facts on the 32 million Health Savings Accounts (including those with no balances) with an average balance of $3,000, according to the Devenir survey:

• 20% have a zero balance.
• 51% have balances of $500 or less.
• 62% have balances of $1,000 or less.
• 74% have balances of $2,000 or less.

Thus, about five of every eight accounts don't have a sufficient balance to meet the $1,000 cash threshold to invest. And many owners don't begin investing at the minimum cash balance because they want easy access to liquid funds (rather than sell mutual funds during a down market) to reimburse at least their annual deductible.

Among the 37% of accounts (that's more than 12 million Health Savings Accounts) with balances exceeding $2,000, only 13% (about 4.2 million) have balances of $5,000 or more - a cash level that would make most owners comfortable placing a portion of their balances into long-term investments.

Who's Investing?

Between 6% an 8% of accounts (roughly 1.95 million to 2.6 million) have a portion of their balances invested in mutual funds and other instruments. Let's accept the midpoint of 7% (2.3 million accounts). That figure represents about 20% of all accounts with balances of $2,000 or more and more than 50% of accounts with balances exceeding $5,000.

Looking at accounts with investments as a percentage of higher-balance accounts (20% to 50% are investing) versus all accounts (7% are investing) paints an entirely different picture.

This picture, although improved, doesn't tell the whole story. Parts remain a mystery:

• What about the other half of owners of accounts with balances exceeding $5,000? Why aren't they investing? The price of medical care has risen at about double the rate of general prices since 1965 (perhaps not coincidentally, the year that the federal government began to influence the market heavily with the introduction of Medicare and Medicaid). Whether general inflation is low (like the average of less than 2% that we've experienced in recent decades) or high (the current year-over-year increase of more than 7%), balances that earn 0.05% to 0.5% interest won't retain their spending power whether the funds are distributed next year or 30 years from now in retirement.
• Why don't owners of Health Savings Accounts without investment options transfer their balances to accounts that offer investments? The bad news is that most Health Savings Account trustees don't offer investment platforms. The good news is that these trustees - mostly local financial institutions whose offerings are little more than checking accounts with paperwork to allow them to operate as Health Savings Accounts - account for a small percentage of total accounts and assets. (In other words, most owners can access an investment platform bolted to their Health Savings Account.) But some employers choose these smaller institutions that don't offer investments, and some savers are earning 0.10% or less return on their funds without realizing that they can make initiate trustee-to-transfer returns to an account that they can establish that includes an investment menu or brokerage feature. Or maybe they know but simply aren't motivated to act. We just don't know.

What's Important?

Sometimes employers approach their trustees or administrators and ask what they can do to increase their employees' investments. It's great that these companies are engaged and genuinely concerned about their workers' capacity to pay medical expenses in retirement. After all, Fidelity projects that a couple that retired at age 65 in 2021 will spend $300,000 on Medicare premiums, Medicare cost-sharing (deductibles, coinsurance, and copays), and services not covered by Medicare (like dental and vision services) during an average retirement (of about 40 years split nearly evenly between them).

By the same token, investments are only part of the equation to increasing employees' financial well-being. In fact, I'd rank it third:

1. Increase enrollment in HSA-qualified plans among employees who are eligible to open and fund a Health Savings Account. Employees who open and fund an account are better able to manage current and future health-related expenses because their tax savings on contributions and distributions helps them save between 20% and 35% on every qualified service or piece of equipment that they purchase. Increasing enrollment from 20% to, say, 40% over three years, for example, will benefit far more employees than merely encouraging the 20% to invest.
2. Increase balances among employees who open an account. When's the best time to open and fund a Health Savings Accounts? The answer is the same as the adage about when the best time to plant a tree for shade is. Of course, the best time was generations ago (the shade tree) or 18 years ago (when Health Savings Accounts became available). The second-best time is today, which trumps tomorrow, next open enrollment, when the kids are off the payroll, or "when I get around to it." Employers don't have total control over balances, but they can leverage their contribution strategy to encourage higher balances. Examples include default elections (new enrollees are automatically set up with payroll deductions unless they actively decline), matching contributions, and activity-based incentives.
3. Encourage investment. This approach is never bad. It's just a matter of prioritizing or segmenting the message to target investment information to those who have high balances without reducing efforts to encourage employees to open and then fund their Health Savings Accounts. Also, choosing an account administrator that offers the option for participants to set their investment options and then sweeps each new contribution into those funds automatically.

The Bottom Line

Yes, it's a missed opportunity when only 7% of Health Savings Account owners invest a portion of their balances. But they're superinvestors, as their balances in equities ($34.4 billion cumulatively) represent 35% of total industry deposits ($98 billion). And their balances are, on average, much higher (more than $19,000) than the average. We know that the amount of time that an account is open is a good predictor of average balance ($21,300 among investors who opened their accounts five years ago, $33,850 for invested accounts opened 10 years ago, and $47,650 among accounts opened 15 years ago).

Employers can't replicate the benefit of time when helping employees leverage investments to build Health Savings Account balances to meet future health-related expenses. But they can design their benefit offerings to encourage more workers to enroll now and start the clock ticking. And they can offer incentives that lead employees to fund their accounts faster.

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