What can the coronavirus teach us about the value of HSAs?

Randy Hardock, partner at Davis & Harman LLP

Families that are fortunate enough to have health savings account (HSA) balances have been better positioned to weather the coronavirus. For them, tax-favored HSAs provide critical short-term resources to offset unanticipated medical costs or, in some cases, to meet other vital financial needs. Unfortunately, far too few Americans have a healthy HSA balance. Most don’t even have an HSA. And the majority of those that do rarely maintain significant balances—instead spending most of their contributions down each year. The question we need to consider is: What would convince more individuals to take advantage of the unprecedented tax benefits1 of using HSAs as both rainy-day and retirement savings funds?

Randy Hardock
Randy Hardock

HSA savings can be used to pay for much more than current health plan copays and deductibles. Tax-free HSA distributions are available for long-term care expenses, certain Medicare premiums in retirement, and a wide range of current traditional medical costs not covered by insurance. For those who have lost jobs, HSAs can be used to pay premiums for COBRA health care continuation coverage under an employer’s plan or other health coverage while receiving unemployment benefits. Now, thanks to the March 2020 CARES Act, HSAs can even be used for non-prescription drugs, other over-the-counter (OTC) medical products and feminine hygiene products. Through December 31, 2021, the CARES Act also allows (but does not require) high-deductible health plans (HDHPs) to cover telehealth and other remote care services before the individual must meet the deductible and coinsurance.

Although the CARES Act changes are useful, they were not designed to encourage more Americans to take full advantage of the long-term savings benefits that HSAs offer. HSAs already provide “triple tax benefits” in that they allow (1) pre-tax contributions, (2) deferral of taxes on investment earnings in the account, and (3) tax-free distributions.1 But even that trifecta of tax advantages has not yet provided sufficient incentive to entice more people to use their HSAs to their maximum potential.

“S” is for savings

Without question, a major reason is that most HSA owners do not adequately appreciate that the “S” in HSA stands for “savings.” Instead, some seem to think the “S” stands for “spending,” often confusing HSAs with flexible spending accounts (FSAs) and often assuming the draconian FSA use-it-or-lose-it rules also apply to HSAs. But without the “savings,” there is no triple tax benefit. HSAs are still a good tax deal, but not uniquely good. And although some people have discovered the wisdom of using HSAs as a retiree health savings fund, most have not. That may be because retirement is seen as far away and people already believe they are saving elsewhere for retirement anyway.

When these difficult times are behind us, a key lesson learned should be a renewed focus on preparing for the unexpected. HSAs alone will not solve that problem, but they can and should be part of the solution. That will occur only if more people can be convinced of the value of having a healthy HSA account balance available to help ride out the next storm.”

Policy proposals to promote increased HSA savings

Progress on breaking through the “spending bias” currently associated with HSAs has been slow. One approach to addressing this challenge is to begin evaluating the dozens of HSA policy proposals currently under consideration in terms of whether they would tend to encourage more HSA spending or saving.

The current crop of HSA reform proposals broadly falls into four categories:

1 Expanding the definition of qualified medical expenses
2 Expanding HSA eligibility
3 Permitting greater HSA contributions
4 Allowing greater insurance coverage

To promote increased HSA savings, the first two categories seem to be of limited benefit. Expanding the definition of qualified medical expenses for purposes of tax-free HSA distributions (like the CARES Act change to allow OTC medicines or proposals to allow HSAs to be used for gym memberships or exercise classes) might arguably increase savings because the added flexibility to withdraw funds will mean greater contributions, but it could also lead to greater spending.

The latter two categories of HSA reforms, however, hold greater promise for increasing savings in HSAs. Clearly, anything that increases the difference between the amount that can be contributed to an HSA and one’s exposure to medical costs will increase the potential for building some level of savings in the account. The simplest approach would be to just allow people to contribute more to their HSAs. In 2020, the maximum annual contribution is $3,550 for self-only and $7,100 for family coverage. There is also a $1,000 additional catch-up contribution for those age 55 or older. One popular legislative proposal would almost double permitted HSA contributions by allowing contributions up to the combined annual deductible and out-of-pocket expenses permitted under an HDHP. Other proposals include allowing unused FSA funds to be rolled over to an HSA and making it simpler for each spouse to make the catch-up contribution.

However, there is another way to create more HSA savings. By expanding the health insurance coverage that an HDHP (or other insurance plan) is allowed to provide, HSA funds would no longer be needed to pay for the additional items covered by insurance. For example, lowering the required deductibles that an HDHP must impose would not only make more health plans HSA-eligible, but it might increase the amount that is actually preserved as savings in any accompanying HSAs.

Similarly, allowing HDHPs to cover more services that do not count against a plan’s deductible or trigger a copay would make it easier to turn an HSA into a savings vehicle instead of a short-term spending account. For example, the narrow definition of the types of preventive medical services that can be provided outside the deductible could be expanded to include routine services that can be provided efficiently at clinics, or to allow a health plan to share in the cost of gym memberships (as is allowed under Medicare Advantage programs for seniors). Other proposals include the temporary telehealth exception included in the CARES Act or allowing an HDHP to provide de minimis first-dollar coverage (e.g., $500) prior to the satisfaction of the plan’s deductible.

The coronavirus has caused enormous disruption and forced many tough decisions, both personal and financial. But it has also provided time for reflection. And when these difficult times are behind us, a key lesson learned should be a renewed focus on preparing for the unexpected. HSAs alone will not solve that problem, but they can and should be part of the solution. That will occur only if more people can be convinced of the value of having a healthy HSA account balance available to help ride out the next storm.

Read more on the benefits of an HSA and how they can help employees manage health care expenses and save for the future.

1 About tax benefits: You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional 20% tax. Any interest or earnings on the assets in the account are tax free. You may be able to claim a tax deduction for contributions you, or someone other than your employer, make to your HSA. Bank of America recommends you contact qualified tax or legal counsel before establishing an HSA.

Davis & Harman LLP is a regular contributor for Bank of America, focusing on legislative and regulatory matters affecting employee benefit plans. The opinions expressed are Davis & Harman’s and do not necessarily reflect the opinions of Bank of America.