Stop Already! 93% of Owners Are NOT - Repeat, NOT - Making a "Mistake!"

Yes, Health Savings Accounts can be used as retirement accounts. But they still deliver value to those who don't save and invest.

The popular press has been publishing articles (see here and here, for example) recently criticizing most Health Savings Account owners for not funding their accounts up to the statutory limit and investing those balances to reimburse qualified expenses in the future - particularly in retirement.

Is this criticism accurate? Or fair?

Health Savings Account Saving and Investing

It's true that Health Savings Accounts are a superior investment vehicle. Contributions through an employer's Cafeteria Plan are deducted from pay before federal income and payroll taxes are applies. And the deposits are free of state income taxes except in California and New Jersey. Balances grow tax-free and withdrawals for qualified expenses aren't included in taxable income. No other popular savings and investment account - think tax-deferred and Roth Individual Retirement Arrangements, or IRAs, and workplace-based 401(k) and similar plans.

The tax advantages extend to retirement. Balances aren't subject to Required Minimum distributions at age 72, as are balances in tax-deferred accounts. Withdrawals for qualified expenses aren't included in taxable income, as are distributions from tax-deferred accounts. That means reimbursing qualified expenses from a Health Savings Account won't add a surcharge to Medicare Part B and Part D premiums or increase the percentage of Social Security benefits subject to federal income taxes.

Investing Health Savings Account Balances

Investment options vary by Health Savings Account trustee. Some accounts - often those offered by regional banks, savings and loans, and other retail institutions - offer interest and no investment options. Some others select a menu of best-in-class mutual funds that allow owners to build a diversified portfolio without overwhelming them with choices (thus avoiding paralysis by analysis that often leaves people with too many choices too confused to act). Still others offer access to a brokerage account that includes all domestic stocks and thousands of mutual funds.

Although many owners enroll in the Health Savings Account chosen by their employers, they're free to open a second account with more attractive investments and make regular trustee-to-trustee transfers to move their balances.

Why Is the 93% Figure Inaccurate?

It's inaccurate and unfair to criticize the 93% of Health Savings Account owners who don't invest their balances. Here's why:

Balances sufficient to invest. Simple math tells us that $96 billion in assets divided by 32 million accounts equals an average balance of about $3,000 per Health Savings Account. That figure exceeds the typical cash threshold of $1,000 or $2,000 for investment. But 20% of accounts had a zero balance at the end of 2021, according to Devenir, the industry's gold-standard researcher. In fact, 62% had balances less than $1,000 and 73% less than $2,000. One might argue that more account owners should be building balances. But that issue is a combination of delivering (account administrators and trustees, plus employers) and receiving (account owners) information about the value of long-term investing. It's unfair to accuse Health Savings Account owners of making a mistake solely because of what's often a meager education effort - and one that's frequently delivered when the accounts are introduced and not reinforced when owners build cash balances high enough to begin investing.

Capacity to save. Most Americans live paycheck-to-paycheck, as many studies demonstrate and articles in the popular press promote. They haven't set aside any money for emergencies. And the average person age 45 to 54 has only $90,000 saved for retirement. It's unrealistic for many Health Savings Account owners to build substantial assets to invest. Yes, perhaps better education would help them appreciate the benefits of diverting a portion of their 401(k) contributions to a Health Savings Account. But that strategy is at least as likely to reduce retirement assets (tapping that money to reimburse qualified expenses tax-free) as to build retirement savings with additional tax benefits. The larger issue - Americans save too little for expected (retirement) and unexpected (emergencies) future expenses - is society-wide. It's unfair to call out Health Savings Account owners.

General failure to invest long-term savings. I can't find a study to confirm this, but ask human-resources professionals about the 401(k) portfolios of their fellow workers and they'll tell you that employees hold far too much of their retirement balances in cash. Blame lack of investing sophistication, fear, or paralysis by analysis, but the fact remains that people in general don't invest an appropriate percentage of their long-term savings in equities with the potential to grow far beyond simple interest. It's unfair to blame Health Savings Account owners for behavior or lack of knowledge that affects the population broadly, not just account owners.

Do the 93% Benefit from Owning Health Savings Accounts?

The answer: Yes. Absolutely.

The frequent criticism I hear when I visit Capitol Hill and enter congressional offices tuned in to CNN is that Health Savings Accounts are for the wealthy only, because only higher-income people can afford to fund an account. This argument is a variation of the historical criticism that Health Savings Accounts benefit "the healthy (those with few medical expenses), the wealthy (those with disposable incomes to contribute), and the wise (those who understand the full value of these accounts).

But that criticism is off the mark. Surveys conducted by administrators of both Health Savings Accounts and Health FSAs show indistinguishable differences among the two groups in family size, age, sex, household income, or medical condition. Yet many members of Congress revere Health FSAs as the working man's ally in managing out-of-pocket expenses and vilify Health Savings Accounts as playthings of the wealthy.

Here's the value of a Health Savings Account: You face $1,200 in out-of-pocket expenses - perhaps an MRI or two dental crowns. You've received the care and are staring at a bill. You don't have $1,200 in a savings account. You have to pay your provider.

You now have two options, whether you plan to pay the bill immediately or negotiate repayment terms with your provider. One approach is to pay with personal funds, which are after-tax dollars. At a 25% combined tax rate (federal income and payroll taxes, state income taxes), you must earn $1,600 to pay a $1,200 bill and the $400 in taxes associated with that money. Alternatively, you can contribute $1,200 to your Health Savings Account tax-free and pay the provider.

See the difference? In either case, you pay $1,200. But you must earn $1,600 to pay the $1,200 bill with personal funds, but only earn $1,200 to pay the same amount from a Health Savings Account. Net benefit to you: $400. That's $400 that you have available for other priorities - for example, filling your gas tank or your cupboard, or saving for a non-medical emergency.

You may fund your account just enough to pay your current bills. In fact, if you've already established your Health Savings Account, you can fund the account after you incur the $1,200 expense in this example. That's right - you can pay with personal funds immediately and the reimburse yourself from future contributions or arrange payment terms with your provider and match those payments with monthly contributions.

Notice that if you fund your account with barely enough money to pay your current bills, you'll fall into the 51% of Health Savings Account owners who ended 2021 with a balance of $500 or less (including 20% with no balance). Many people infer that those owners received no benefit from their accounts because they didn't end the year with a hefty cash balance for future expenses.

But owners who use their Health Savings Accounts this way are no different from Health FSA owners, who ideally end the plan year with zero balances as well. Yet no one would argue that Health FSA owners didn't receive benefits from their account because they ended the year with no remaining balance. Instead, observers would note that people were using their Health FSAs properly and receiving tax benefits.

The same hold true with most of the 93% of Health Savings Account owners who maintain balances only in cash and don't accumulate six-figure balances to distribute in the future.

The Bottom Line

Feel free to express concern that many of the 27% of Health Savings Account owners who have accumulated balances of $2,000 or more aren't investing their balances in equities. And criticize a host of players - Health Savings Account trustees and administrators, employers, financial advisors - for not encouraging higher-income employees to enroll in Health Savings Account programs or for not educating owners with balances above $2,000 about the benefits of long-terms savings in Health Savings Accounts versus other opportunities.

But don't deliver blanket criticism of 93% of the population of Health Savings Account owners because they don't understand the benefits of investing balances . . .or don't have sufficient balances . . . or don't have the income to fund any long-term savings . . . or simply don't value long-term savings versus short-term consumption with any dollar that they earn.

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