A Health Savings Accounts (HSA) lets you save money pre-tax to use for medical expenses at any time in the future. You can also invest the money if you plan to use it in the distant future, such as in retirement. It’s one of only a handful of vehicles for pre-tax investing, which makes it very attractive. HSAs exist in large part to get people to enroll in a High Deductible Health Plan (HDHP). Even though HSAs look attractive financially, they are non-financial drawbacks that are not obvious at first.
Benefits of HDHP + HSA
The premium — the amount of money coming out of your paycheck automatically — for an HDHP will be lower than an PPO or HMO. How much lower will depend on your employer’s contribution, but it could be a low as a $500 a year. By itself, this is probably not motivating enough to switch. The main benefit is the pre-tax savings. In 2023, the limit on HSA contributions is $7,750 for a family. That comes off of your taxable income for the year. If you are paying close to the marginal tax rate of 37%, that would save you about $2,800 in taxes. Many employers will make their own contribution to the HSA, which could be thousands of dollars. This is extra free money.
The real incentive is investing that money. If you invested the whole $7,750 in an index fund that returns 7% a year for 15 years, you would contribute $116,000 and it would grow to $194,000 in those 15 years. That return gets larger over long time horizons. If you did the same thing for 30 years, you would contribute $232,000 and it would grow to $731,000. This is the primary attraction to an HSA for people already maxing out their other pre-tax investment vehicles.
Note: leaving contributions to grow requires that you don’t use the HSA money to pay for in-year medical expenses. This means that your post-tax expenses in the current year would increase up to your HDHP deductible, typically something like $6,000 for a family. On paper, the pre-tax benefit of the HSA is still worth it.
How HDHP + HSA Works
When you’re on an Health Medical Organization (HMO) medical insurance plan, you do not get billed directly for most medical expenses. You may receive a statement in the mail that says “this is not a bill”, as a cost transparency mechanism. But, you only have to pay the premium — deducted from your paycheck — and small per-visit copays. When you’re on an HDHP, you get billed for medical expenses from the service provider, and you need to pay those bills until you hit the deductible limit on your plan. After that, you will mostly not get billed and the insurance covers the additional expenses, with the exception of copays and potentially a small percentage-based co-insurance payment. You should keep receipts for any medical expenses you want to get reimbursed for.
The HSA is designed for you to tap into your pre-tax HSA contributions to pay for these expenses before you hit your deductible. For small expenses, you can use a debit card they issue you. For larger expenses you do this by logging in to their website and telling them how much of the funds to send back to you. This can be either a check in the mail or a direct deposit. The HSA provider will not ask you for a receipt for your expenses. When you file your taxes for the year, you will declare how much you contributed to your HSA and how much you were reimbursed from your HSA. You will not need to submit receipts, but you should keep them for seven years in case you are audited.
You invest HSA funds through the HSA provider’s website. Similar to a 401k provider, you select contributions amounts and which funds you want to invest it. With an HSA, you are selecting one contribution amount for how much additional money you want to deduct from your paycheck to put into the HSA, plus a second amount that you want to be moved from your HSA cash balance to your investments.
Downsides of HDHP + HSA
The downside of an HDHP + HSA that everyone knows about is the contribution amount. There is more money coming out of your paycheck. Assuming you contribute pre-tax to the HSA, that will more than offset the savings in premiums. People who are already maxing out their other pre-tax savings vehicles see this as a benefit; it’s reducing their taxable income and increasing pre-tax investments. But, the short-term negative cash impact is nonetheless a downside — and the most well-known one.
Billing Errors
Increased paperwork and exposure to medical bureaucracy are less well-known downsides. When you’re on an HDHP you need to keep track of and pay medical bills. When you’re on an HSA, you need to keep receipts for medical expenses. If you’re on an HMO you may never have looked closely at a medical statement. It’s common for various doctors and specialists involved in something like a visit to the emergency room to all send you different bills. There are often mistakes on the bills, such as being double-billed for something. There is not a lot of clarity on exactly what an item on the bill represents. If you’re on an HMO you don’t really care. If you’re on an HDHP, you may very well find yourself calling your insurance company to figure this stuff out. They will often need to bring someone from the service provider (hospital) into the loop to sort it out. All this takes time, and is frustrating.
Unreasonable Medical Costs
Exposure to absolutely insane, detached-from-all-reality, inside-baseball itemized medical costs are the next downside. On an HDHP, you are incentivized to spend less on medical expenses, until you hit your deductible. Did you know that something like a 1-hour speech therapy session for a child can cost $700? You will get bills like this from the provider. You may very well not be able to find out how much it costs until after the service. It doesn’t matter that the going rate for this service outside of insurance is $150. When they bill you this amount, it’s not negotiable. If you’re on an HMO, you don’t care what inflated price the provider is changing themselves.
Tax Paperwork
The next downside is tax complexity and audit risk. When you file your taxes, you will submit a form 8889 for your HSA. You report contributions and distributions. This is not a big deal, it’s just one more thing to keep track of. HSA providers do not send this form to you, like 401k providers do. You need to fill it out manually. You don’t need receipts for medical expenses either when you request a distribution from the HSA provider, or when you file your taxes. You will need your receipts if you even get audited, however.
Bad HSA Providers
You are locked in to the HSA provider that your company chooses. Like 401k providers, there is a wide range of quality here. The company has an incentive to pick the lowest cost provider, not the one with the best website or customer support. In short, there is a good chance the only provider you can use will be terrible. Websites may be poorly implemented. There may be no phone number of call for customer support — instead you may be directed to your internal benefits team. There may be limitations on the number of transactions you can make. There may be annual fees.
Your company may also change providers. Your cash funds may or may not be rolled over to the new provider automatically. Even if cash funds are moved, investment funds may not be. There is the added complexity of special “in-kind” transfers that are necessary for avoiding tax implications of moving to a new HSA provider. You may or may not be able to do an in-plan (i.e. without leaving the company) transfer to your own third-party HSA provider. But, you will not be able to use a third-party provider for automatic contributions from your paycheck and your employer. Over the course of a long career, you may end up with many different HSA accounts at many different providers, unless you spend time to consolidate them.
Psychological Cost
Don’t underestimate the added element of decision making on top of all medical decisions, especially when there are family members and spouses involved. Even if the cost of medical treatment up to your deductible is a negligible expense in your overall budget, you may be surprised to find yourself in protracted conversations about whether it’s “worth” getting various medical treatments. Maybe your knee is bothering you, but it’s not a show stopper. Do you get an MRI, even if that might cost you $1500 dollars out of pocket? This is one of the points of a HDHP, from the perspective of the insurance company — to make consumers more aware of medical expenses. They know that this will reduce unnecessary medical expenses. But, it will also reduce necessary preventative expenses.
Identity Theft
One of the primary use cases for an HSA is paying for medical expenses. You will get a debit card sent to you for this purpose, whether you want one or not. You will be required to create a username and password for the website of the HSA provider. This website is like small bank account, where anyone with your password can make a deduction. Both the debit card and the website are vectors for identity theft and potential financial loss. Neither of these are purely theoretical threats — there are news articles about fraud happening in the wild.
Conclusion
Enrolling in an HSA is not a one-way door. You can typically make a different election once a year, or when you change employers or at certain qualifying life events. If you save a large amount of money in an HSA and then switch back to an HMO, you may have trouble spending that money. It’s not clear what expenses are eligible when you’re no longer on an HDHP. It’s difficult to research, but you are probably fine to expense copays and any services or medications purchased outside your insurance. Plus, you can still save the money for medical expenses in retirement.
What would it take to “fix” these risks to HSA programs? Medical costs would need to become both understandable and reasonable. You would need to be allowed to choose your own HSA provider. Neither of these are likely to happen.
In the meantime — as with many aspects of finances — you can’t go wrong with keeping it simple. For medical insurance, it doesn’t get any simpler than an HMO.