Is HSA Investing a Sprint or a Marathon?

The marketplace for investing Health Savings Account (HSA) assets continues to evolve slowly, and the HSA investment experience tends to match the short-term nature of the objectives most employers have in adopting HSA-capable coverage.

The objectives most employees have in HSA participation are: 

• Minimizing premiums—HSA-capable coverage is often the lowest cost alternative. 
• Making tax-deductible contributions—assets will qualify for tax-favored uses. 
• Moderating health care trend—higher point of purchase cost sharing (deductibles, not copays) may prompt consumers to better manage their health services utilization. 

Most focus on current year needs and spending. Most workers contribute only what they expect to spend this year, and more than 85% of HSAs have minimum balance requirements before an account holder can invest in something other than a cash equivalent. That results in myopic investment allocations—reducing the selection of investment structure and investment decision-making to a secondary or tertiary consideration. Fully 95+% of HSAs are invested in cash-equivalent vehicles.[i] Sometimes, the account provider’s margin on cash equivalent investments is substantial. 

However, it’s been said that those who ignore the past are doomed to repeat it—and continuation of these past practices severely underutilizes the HSA’s asset accumulation potential.[ii]

Investment Structure Selection Process

Few recognize employers and employees are participating in a retiree medical funding marathon. Initial investment selections are often an afterthought for plan sponsors once they decide to adopt HSA-capable coverage since employers and vendors immediately lose control over HSA assets (accounts are individually owned, and participants can transfer assets any time). 

To avoid application of ERISA’s fiduciary responsibilities, almost all employers accept the HSA account provider’s investment recommendations, probably after a cursory review. HSAs and IRAs are both subject to prohibited transaction requirements. Unsurprisingly, because they have different adoption and selection processes and different service providers, only 3% of HSAs offer the same investment lineup used in the 401(k).

However, a Devenir white paper suggests HSA investors have different needs and a wider range of use cases for HSA assets, that HSA investments should include: 

• more choices than a 401(k) menu; 
• a mix of asset classes focused on growth without introducing excessive risk; and
• a mix of active and passive, and universal choices (allocation, target date). 

Here are most of the tax-favored use cases for HSAs an employer may want to consider in investment menu construction: 

1. Medical, dental, vision, hearing, and long-term care out-of-pocket expenses: 

• Current and future year expenses while employed
• Similar expenses incurred post-employment

2. Current and future year insurance premiums eligible for tax-free reimbursement:

• COBRA and certain COBRA-like coverage
• Qualified long-term care
• Medicare Part B and Part D premiums—including income-based premiums
• Employer-sponsored retiree medical premiums: traditional cost sharing; retiree-pay-all, fully insured Medicare Supplement, Medicare Advantage 

3. Surviving spouse and other tax-dependent qualifying expenses (items #2 & #3 above)

4. Penalty-tax-free income after age 65

5. Death/legacy income to non-spouse, non-tax-dependent beneficiaries. 

Note, however, that because the median tenure of American workers has consistently been less than five years for the past five or so decades, most of the uses shown above apply after current employment has ended, meaning that employer and HSA account holder priorities may be substantially different. 

On Your Marks at the Jumping Off Point

The nascent movement to change the HSA’s focus, objectives and goals must expand to include retiree medical costs. Saving more is an imperative—including saving for expenses beyond the current year. However, saving more isn’t enough. Greater savings must be accompanied by improved investment decision-making—in selecting investments and allocating HSA assets. 

A few have prompted strategic change by deploying automatic features—defaults that might apply to enrollment, contributions, escalation or even investments. For example, some 30% of employers automatically enroll employees in the HSA once they enroll in HSA-qualifying coverage. In 2018, the Department of Labor clarified the use of automatic features in welfare benefit plans.[iii]

The HSA’s past is not its future. Some HSA programs are now 16 years old. From 2006 to 2019, according to Devenir, HSA assets have increased from $1.7B to $65.9B, a growth rate of 32.5% per year. That’s the past. It is possible, but not likely, that embrace of automatic features could prompt continuation of past trends. Certainly, we’d like to capture some of the all-time-high in personal savings as individuals change their spending due to COVID-19.[iv] Continuation of these trends suggests HSA assets under management could exceed $1 trillion before 2030. 

That claxon sounded the start of the retiree medical funding marathon.