Health savings accounts differ from flexible spending accounts in a number of ways: HSA balances can be rolled over in full year to year; funds deposited in HSAs can be invested; and capital gains and dividends earned are not taxed– the third of HSA’s trio of tax advantages. One of the more surprising discoveries in our recent analysis of HSA account holders is that very few workers are taking advantage of this particular tax benefit.
The account holders in the population we studied were eligible to invest their HSA funds if they had balances greater than $1,000. We found that more than a third of account holders were eligible to invest their HSA funds, but only 4 percent of them actually did. Account holders who do not wish to use their accounts as spending vehicles in the near term are missing an opportunity to grow their health savings through interest and investment returns, neither of which will be taxed upon withdrawal if spent on a qualified medical expenditure. Opting to keep HSA balances in checking accounts that do not bear interest causes account holders’ buying power to be eaten away by inflation.
Of course, there are rational reasons to keep HSA funds in a non-interest-bearing account. If significant medical expenditures are anticipated in the short term, it makes more sense to keep at least a portion of those funds in a checking account rather than expose it to market risk.
However, in the longer run, the difference between choosing to invest and keeping the entirety of funds in a checking account is staggering. Assuming a return of 4 percent per year, an account holder who invests their HSA balances will have accrued more than twice as much in their HSA compared to an account holder who does not invest after only 20 years. Furthermore, the non-investor’s savings will have been slowly eroded by inflation – their balance will be worth about 20 percent less in real terms, assuming 2 percent inflation annually over those 20 years.
We also found that account holders who invested their HSA funds were systematically different than those who did not in a few ways. Investors were richer than non-investors, had higher educational attainment, were more likely to be male, and were more likely to have had their accounts for more than a year.
Curiously, on average, investors spent more money from their HSAs than non-investors. One might think that an account holder who invests their funds would wish to spend out of pocket for health care expenses they incur, and let their principal to take advantage of compounding interest and maximize their market returns. Instead, what we observe is that investors spent more from their HSAs than other users. This may very well be an indicator of engagement; account holders who invest their HSA balances may also be more confident in utilizing their HSAs for medical expenditures.
There are some encouraging signs. Virtually all investors were account holders who opened their account over a year ago, suggesting a relationship between account tenure and usage. Perhaps the longer an account holder has held their HSA, the more comfortable they feel utilizing all of its features. Engagement is likely a large factor here– improved messaging and education around this particular aspect of HSAs may be enough to move the needle, as well.