HSAs grow in popularity, but regulatory hazards still lurk

Since their inception, Health Savings Accounts (HSAs) have followed the same, functional format. Offered in conjunction with a high-deductible health plan, they’ve acted as a short-term holding tank for employee dollars to cover medical expenses incurred before reaching plan deductibles.

The format has been a success. But a new trend is emerging: the use of HSAs as longer-term savings vehicles. The proportion of HSA dollars invested in stock and bond funds, vs. merely kept in the equivalent of a savings account paying minimal interest, has been growing steadily.

Although you might consider this a positive development, and an indication that your employees are planning for the long term, it’s important to be aware of the regulatory impact. Specifically, important HSA-related Department of Labor (DOL) regulations are scheduled to take effect in part next April and fully in 2018.

Retirement strategy

According to the 2016 Midyear Devenir HSA Research Report, total assets in these plans (based on reporting from the 100 largest providers) hit $36.4 billion on June 30, 2016. That’s nearly triple the amount from five years ago. In addition, the amount of HSA dollars (out of that $36.4 billion total) invested today, at $5.4 billion, is about the same as the total amount of dollars in all HSAs back in 2008. Also, the proportion of HSA dollars invested today, at 15%, is projected by Devenir to grow to 17% of the total (to nearly $9 billion) in two years.

These numbers suggest that some employees are beginning to recognize the potential of HSAs to do more than fund current medical expenses. In particular, they can also use these accounts to build funds to pay health care costs in retirement on a more tax-efficient basis than traditional retirement savings vehicles.

When retirement is well off into the future, retirement dollars invested in stocks and bonds are likely to accumulate at a higher average rate than dollars merely stashed in a deposit account. But 401(k) investments offer only a tax deferral as a benefit. HSA dollars, when ultimately spent on qualified medical expenses, are triple tax-free. That is, taxes aren’t assessed on:

  • Income deposited into HSAs (in other words, pretax),
  • Withdrawals, or
  • Accumulated investment gains.

HSAs even beat Roth IRAs and Roth 401(k)s, which are funded with after-tax dollars and offer tax-free earnings and principal distributions.

What’s more, because it doesn’t matter when medical expenses are incurred for purposes of tax-free reimbursement from an HSA, an employee could have a tax-free windfall at retirement. For example, let’s say an employee has paid out of pocket for $50,000 worth of medical expenses by the time she retires (and kept the documentation) and has $100,000 accumulated in her HSA. She could then reimburse herself from the HSA for all of the previous $50,000 in out-of-pocket expenses — and not pay a dime in taxes on that withdrawal. This might fund some or all of the employee’s first year of retirement!

In contrast, a $50,000 withdrawal from a traditional 401(k) account in retirement would be fully taxable. Therefore, the retiree would be left with perhaps $40,000 or less after taxes, depending on his or her combined federal and state tax bracket.

Dollar limits                     

The challenge for employees with HSAs — particularly lower earners — is to postpone using HSA savings as long as possible to maximize the tax benefit. And the higher the health care plan deductible, the more challenging doing so can be.

How challenging? The employee out-of-pocket expense ceiling for high-deductible plans will go unchanged for 2017: $6,550 for individual coverage, and $13,100 for family coverage. Minimum deductibles for a high-deductible plan (which qualifies to have an accompanying HSA) are also unchanged for next year: $1,300 for self-only coverage, and $2,600 for family coverage. (To call health benefits using those lower limits a “high-deductible” plan may sound like a misnomer, but those are the rules.)

The maximum annual HSA contribution for self-only coverage rises by $50 to $3,400 in 2017, but the ceiling for family plans remains unchanged at $6,750. Employees age 55 or older can add an additional $1,000 in “catch-up” contributions.

DOL regs

There’s a caveat, however, when giving employees the opportunity to use an HSA as a long-term savings vehicle through the inclusion of investment options in the plan. It’s that, as noted above, employers could become subject to the new DOL regulations addressing fiduciary status.

The rules are primarily aimed at investment advisors who give retirement investors advice regarding IRAs and defined-contribution plan accounts. In a nutshell, the regs confer fiduciary status and, thus, greater liability on advisors who perform this function. (The rules do provide some wiggle room for nonfiduciary advisors who enter into a “best interest contract exemption” agreement.)

In the fine print, the regulations also cover HSAs, and the fiduciary burden generally falls on independent HSA administrators. An HSA isn’t technically an ERISA plan, but it can become a de facto one under certain conditions. When it does, employers are then also subject, in part, to the regulations.

The greater an employer’s involvement in and control over the HSA offered, the higher the probability it would be deemed an ERISA plan. For example, if an employer got involved in picking individual investment HSA options, that could push the HSA toward de facto ERISA status.

Therefore, it’s generally best to let the HSA administrator do the communicating with employees about their options under the plan, including the potential long-term tax benefits. Alternatively, employers can simply relay information from the HSA administrator to employees without commenting on them.

Of course, choosing to become an HSA administrator to begin with might be considered a fiduciary act. Still, avoiding fiduciary liability under the DOL regulations for the day-to-day operations and investment aspects of the HSA is advisable to the extent allowed. After all, doing so doesn’t prevent your employees from reaping the possible rewards of salting away some or all of their HSA contributions for use in retirement.

Details and rules

With the advent of the Affordable Care Act, employers have been digging deep into their health care benefits options to find optimal ways to control costs, provide good coverage and comply with the law. HSAs have been around since well before health care reform and remain quite viable. Just be sure to keep up with all applicable details and rules, including the forthcoming DOL regs, while offering one.