Do Low Balances Indicate That HSAs Benefit Only Wealthy Owners? Nope!

Half of Health Savings Accounts have balances less than $500. What does this data point mean?

When I speak with legislative aides to members of the US House of Representatives and Senate - an activity that, during the pandemic, has been curtailed but, thanks to technology, not eliminated - about tax-advantaged accounts, I'm always met with predictable reactions.

Aides to elected Democrats, to the extent that they have an opinion, generally favor Health FSAs, which they describe as in terms like the working family's reimbursement account. They are skeptical to sometimes downright hostile to Health Savings Accounts, which they see as (1) another opportunity for the rich to become richer and (2) a foundational element in any Republican plans to repeal and replace the Affordable Care Act.

Republican offices are respectful of both plans but usually favor Health Savings Accounts, on which many of the GOP's healthcare reforms of the last decade are based. R3epublicans generally understand and appreciate the tax benefits that both programs offer, but they're bullish on Health Savings Accounts because the contribution limits are higher, qualified expenses include some medical premiums (a key element in some of their reform attempts), and unspent balance aren't subject to forfeiture.

Studies of relevant characteristics of Health Savings Account owners and Health FSA participants - household income, age, family size, medical status, spending on qualified expenses - show very little difference between people who use one account or the other. There is but one variable, however, that's highly correlated with whether someone enrolls in a Health FSA program or owns a Health Savings Account: which plan the employer offers.

Stereotypes die hard, however. And one of the frequent criticisms of Health Savings Accounts - an echo of the concerns expressed by Democrat offices - is that most Americans don't have enough discretionary income to fund accounts to the statutory maximum ($3,650 for self-only and $7,300 for family coverage in 2022, plus an additional $1,000 annual catch-up contribution beginning at age 55). Thus, Health Savings Accounts benefit only the wealthy.

The Facts

The leading survey of the Health Savings Account market, conducted semi-annually by Devenir Research, shows that 18% of accounts had no balance in mid-2021 and another 31% had balances between $1 and $499. In other words, roughly half the accounts had balances under $500.

On its face, that report would seem to support the general Democrat view that these accounts don't provide much benefit to working-class families because they're not able to build balances for future qualified health-related expenses as higher-income owners are.

But there's more to the story than account balances at a single point in time.

Health FSAs

Health FSAs share some important features and benefits with Health Savings Accounts. Health FSA elections, like most Health Savings Account contributions, are pre-tax. Both accounts reimburse the same core qualified expenses - necessary medical, dental, and vision services, plus many over-the-counter items - tax-free.

But Health FSAs are annual, time-bound reimbursement plans, not timeless savings accounts. The plans renew each year, and balances not spent are forfeited. Employers are permitted to extend the time period to spend balances by adding either a grace period (up to an additional two and a half months to spend balances after the plan year ends) or a limited carryover (up to $580 - the 2022 figure - rolled over to spend during the following plan year). But the opportunity to spend balances is always defined, and it's never infinite.

Thus, when properly managed, a Health FSA has a zero balance at the end of the plan year. Given the goal not to forfeit funds, it's reasonable to assume that 95% or more of Health FSAs end the year with balances less than $500. That figure is nearly double the percent of Health Savings Accounts with similar balances at any point in time.

So, where's the outrage that most Health FSA have a zero balance at the end of the plan year?

The Benefit of a Health Savings Account

Let's imagine a typical Health Savings Account owner with a household income of $92,000. The family doesn't have a lot of discretionary income after paying taxes, saving for retirement and perhaps other priorities, and absorbing the expenses of daily living (a growing challenge). She commits to funding her Health Savings Account to the tune of $2,000, which comes out to about a $77 pre-tax deduction from every biweekly pay check.

Why this figure? She knows that during the past several years, her family has spent about that much on medical deductibles, prescription drugs, a few fillings at the dentist, and new glasses and contact lenses. She expects spending this year to be about the same.

And she's pretty much nails it. The family spends $1,900 that year, leaving her with a $100 balance in her Health Savings Account that never expires. At the end of the year, her account trustee studies its business and reports that she is among the 50% of account owners with a balance of less than $500 at that moment in time.

The implication is clear to many: She didn't benefit from her Health Savings Account because she couldn't fund it at a sufficient level to build a balance of - pick a figure: $1,000? $2,500? $5,000?

But let's examine her account. She contributed $2,000 through pre-tax payroll deductions. She saved the following in taxes:

• $440 in federal income taxes (at a 22% marginal rate that applies to her income level)
• $153 in federal payroll taxes
• $100 in state income taxes (assuming a 5% flat rate)

That's $693 in tax savings, or just under 35%. In other words, she has $693 more to spend on other priorities - a weekend away, some auto repairs, gymnastics camp for her daughter - than she would if she's spent the same $1,900 without running that amount through her Health Savings Account. Put another way, absent a Health Savings Account, she would have to earn a little more than $2,700 to pay her $1,900 of qualified expenses and the taxes applied to that amount of income.

Yet in the static world of taking a snapshot twice a year of all Health Savings Accounts, it appears that this owner received no benefit because she had but a small balance ($100) at the time of the survey.

The Bottom Line

Health Savings Accounts provide owners with the opportunity to enjoy tax savings. Owners receive that benefit when they fund their accounts, whether they spend the funds immediately or retain balances for future expenses - sometimes as far into the future as retirement.

Whether someone can afford to fund a Health Savings Account or not isn't relevant in determining value. Patient who owe money to a medical provider must pay. If they don't own a Health Savings Accounts, they pay with personal (after-tax) funds and enjoy no tax benefit. If they do have a Health Savings Account, they can typically save between 20% and 37% on all qualified health-related services by paying through a Health Savings Account.

That financial benefit often doesn't show up in a snap-shot look at Health Savings Account balances.