Disadvantages to Owning a Health Savings Account? Hardly!

An article attempts to show the pros and cons of a Health Savings Account. The list of disadvantages is a stretch.

I recently read an article about Health Savings Accounts that attempted to give a balanced view of this remarkable opportunity. The author offered a balanced list of benefits and shortcomings of Health Savings Accounts.

The list of benefits included tax advantages, no minimum deposit, carryover of unused funds, portability, and insured cash deposits. The article also pointed out that balances can reimburse Medicare premiums, though the brief description understates the Health Savings Accounts' role in helping couples retiring this year at age 65 manage an average of $315,000 in remaining-lifetime qualified health-related expenses. For example, a retired couple paying that same amount from funds withdrawn from a tax-deferred 401(k) plan or Individual Retirement Arrangement would spend about $394,000, including taxes (assuming a 20% federal and state income tax rate).

The problem that the writer encountered is that Health Savings Accounts are so overwhelmingly beneficial that it's difficult to craft a list of similar length that highlights the shortcomings of these accounts. Not when a family with high claims can save more than $2,000 in taxes by depositing the statutory maximum $7,750 (assuming a 27% combined federal payroll and federal and state income tax rates). And not when they never forfeit balances not used in a given year, can invest balances, retain their funds even when they're no longer eligible to fund an account, and can leave their balances to an heir (including tax-free to a spouse).

The Listed Disadvantages

Here are the disadvantages cited in the article (in quotation marks), along with a commentary in why the disadvantage is incorrect, overblown, or a stretch:

"Potential tax drawbacks: Prior to age 65, HSA funds withdrawn to pay for nonmedical expenses are considered taxable income. The IRS also levies a 20 percent penalty. Expenses can be audited by the IRS so you should keep receipts for all payments made with HSA funds. If you don’t stop contributing to your HSA six months before you apply for Social Security benefits, tax penalties may apply."

Analysis: Another way of stating this issue: If you don't follow the rules, you pay a penalty, just as you do when you make premature distributions from a retirement account, break an auto lease early, or withdraw funds from a certificate of deposit prior to maturity. The rules about how to use Health Savings Account funds are clear. If people choose to sever the relationship between tax savings and qualified expenses, they pay a steep price. But if they follow the simple rule of limiting distributions to qualified expenses, they never face taxes or penalties on the funds.

"Not everyone is eligible: If you are claimed as a dependent on someone else’s tax return, you’re ineligible for an HSA."

Analysis: This argument is rather like criticizing college savings programs because not everyone has children who will attend college. Yes, if someone else is responsible for more than half your living expenses, you don't enjoy a tax break. You're probably not the one paying medical premiums or covering your out-of-pocket expenses. But the person who is supporting you can enjoy tax savings.

"For people enrolled in HDHPs only: Only those with high-deductible health plans qualify for an HSA. Meeting a high insurance deductible might be a hardship."

Analysis: High deductibles are a reality - and a hardship for many people. According to Kaiser Family Foundation, in the 2023 federal-facilitated marketplaces ("public exchanges"), the average deductibles were about $7,500 for bronze plans and $4,900 for silver plans. Among silver plans (the plans that are the reference point for affordability calculations and taxpayer premium subsidies), only 18% of plans purchased have deductibles below $3,000. That figure is important because the statutory minimum annual deductible for an HSA-qualified plan is $3,000. In other words, most exchange enrollees - as well as most small-group and many large-group employees - already face deductibles equal to or greater than the statutory minimum for an HSA-qualified plan. The only question is whether these people are enrolled in plans that meet the design requirements to open and fund a Health Savings Account. Most aren't. They experience the high deductibles without the opportunity to pay their cost-sharing and other qualified expenses at a 25% to 35% discount.

"Rejection of HSA cards: Not all stores accept HSA debit cards, so you may have to pay for your expenses out of pocket and get reimbursed by your HSA trustee."

Analysis: You'd be hard pressed to find a merchant that rejects Health Savings Account debit cards. Cards are issued by either Visa or MasterCard and work on those systems' networks. These systems don't distinguish between Health Savings Account cards and any other debit or credit card. The reason a card may be rejected is that the business has self-identified with a merchant code that doesn't typically sell HSA-qualified items (like a furniture store, casino, auto-repair shop, or liquor store). But rather than a problem, this configuration provides protection against pulling the wrong card out of your wallet when paying for a non-qualified expense.

"Weak earnings and investment limits: Interest rates on HSA accounts may be low and some trustees charge a monthly fee if your balance drops below a certain threshold. Minimum balance requirements may apply before you can invest; investment options may be limited and investments are not insured."

Analysis: This argument also is a criticism of all bank accounts and retirement savings plans. They too generally offer interest rates far below general inflation and may charge a monthly fee. Many of the leading Health Savings Account providers offer fee-free accounts, allow investments with little or no cash balance, and offer a menu of mutual funds and perhaps even a brokerage platform for investments. To criticize the entire Health Savings Account program because of the shortcomings of some administrators' offerings would be like having been suspicious of the domestic automobile market in the late 1980s because some dealers sold Yugos. (Look up Yugos here, younguns!)

"No more contributions: Once an individual reaches age 65 (the age for Medicare eligibility), additional contributions (including catch-up contributions) can no longer be made, even if still employed."

Analysis: Really? This is a disadvantage? Taxpayers are no longer eligible to deduct mortgage interest once they've sold or paid off their home. But no one criticizes the mortgage deduction because it's not a lifetime program. In fact, most workers have four decades or more to enjoy tax savings on their contributions, the growth of their balances, and their withdrawals for qualified expenses. Besides, this criticism is not true. Becoming eligible to enroll in Medicare is not an event that disqualifies you from making additional contributions. But enrolling in Medicare is disqualifying. If you're a working senior, you delay Medicare enrollment, and your company has 20 or more employees, you're not required to enroll in Medicare. You can work indefinitely, remain covered on the company's HSA-qualified plan and, if you have no disqualifying coverage, continue to fund a Health Savings Account indefinitely.

The Bottom Line

All consumer markets - think homes, cars, churches, and cell-phone plans - offer a wide variety of options. Some goods and services offer better value than others. Some are more appropriate than others for specific buyers. But that range of products and consumer tastes is hardly a criticism of living under a roof, seeking a mode of transportation faster than two feet, worshipping a God, or disconnecting from the world.

Americans have saved more than $100 billion in more than 34 million Health Savings Accounts during the past two decades because these accounts offer immediate tax benefits, create a medical emergency fund, and can offset out-of-pocket medical expenses in retirement.

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The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.