Roth IRAs have caught on as weapons in Americans’ wealth-building arsenal: Attracted by their double-tax-free treatment—after-tax contributions grow and are withdrawn tax-free—retirement savers have socked more than $1 trillion into them. But the “medical IRA” strategy of using triple-tax-free health savings accounts to fund medical expenses in retirement hasn’t caught on. Does the financial advice industry bear some of the responsibility?
“We’d argue that HSAs are probably the most powerful vehicle in the entire tax code, even probably more than the Roth IRA,” says Michael Henley, the founder and CEO of $1.25 billion-asset Brandywine Oak Private Wealth, in Kennett Square, Pa.
The medical IRA strategy involves contributing to a health savings account, preferably maxing out the annual contribution limit, which is currently $4,150. HSAs must be paired with high-deductible health plans, of course. The funds are invested with a multi-decade time horizon, with allocations similar to those in retirement accounts. Before retirement, medical expenses are paid out of pocket, allowing the HSA balance to compound tax-free, and you keep your receipts. When you tap your HSA in retirement, you repay yourself.
As an example, if you invested $4,150 a year between ages 30 and 65, and your balance compounded at 8% annually, you’d have approximately $500,000 to spend on everything from Medicare premiums to prescription drugs, tax-free, in retirement.
It seems like a no-brainer, especially if you’ve got enough cash flow to cover medical costs while your account balance grows. “It’s a good way for people to sock away money, says Ann Zuraw, president of $316 million-AUM Zuraw Financial Advisors, in Greensboro, N.C. “If you can build it up, you really could be ahead of the game.”
But it turns out that the vast majority of account holders, including high earners, use their HSAs as debit accounts to pay those medical bills. Just 4% to 5% of HSA account owners max out their contributions every year, even though some employers match contributions, and 10% or fewer invest those balances in something other than cash, says William Stuart, an HSA expert who is a consultant and author. “Too many are using these like health flexible spending accounts, as an annual reimbursement account,” he says.
There seem to be a few reasons why. It’s safe to say that insufficient income is one. Another is the fact that few account owners are disciplined enough to max out those contributions and leave them alone to grow. It’s part of why Zuraw, who recommends the strategy when it makes sense, says only about 10 of her 155 clients use it. And not only does the “medical IRA” strategy require the high deductible plan and HSA combo, but the HSA must provide access to longer-term investments rather than just deposit accounts.
Savers’ investment options typically depend on their employer. Workers usually get an HSA through a bank or brokerage company that has partnered with their companies. Smaller banks and credit unions offering HSAs typically provide money-market accounts and perhaps a CD option; they lack long-term investment options. Other employers offer a menu of perhaps two or three dozen mutual funds. The luckiest workers’ companies partner with firms like Fidelity or HSA Bank to offer account holders full access to public markets.
Without built-in investment access, employees might have to get creative to make the medical IRA strategy work. While building his balance, Stuart has periodically moved funds from his employer-provided HSA to a private one with a brokerage account that he opened.
Lack of education and guidance are also holding adoption of the strategy back, Stuart says: “People don't understand this concept well enough.”
Henley seconds that. “Most individuals, even at the upper echelon of wealth, put the money in and take it out that year or the year after that, almost like a glorified savings account,” he says.
This is where advisors can help—but too often fail to do so, says Henley. One reason is that advisors don’t want anything to do with medical plans or medical coverage. “You need to be enrolled in an HSA-eligible high-deductible health plan to be eligible to make contributions,” he says, “and they don’t want to get involved in clients’ medical-plan decisions.”
Another may be the perception that there just isn’t much money to be made in managing HSAs. Only 7% of HSA account owners have balances of $10,000 or more, according to Devenir Research. Managing fat IRA rollovers, not measly HSA balances, is what advisors are after. “There’s not a real revenue play for financial advisors,” says Stuart. “There’s no million-dollar balance to play with.”
Stuart experienced this bias firsthand a few years ago while advisor shopping: His own HSA has a six-figure balance, but advisors he interviewed were fixated on his retirement balance.
Henley says other advisors scoff when he brings up the medical IRA strategy on conference panels. But he’s accustomed to it. “We used to work at Merrill Lynch, and the whole office would kind of laugh at us for bringing it up,” he says. “I would say ‘This is the wave of the future—we’re going to give holistic advice on everything the client has.’”
Another problem seems to be that by the time many clients seek out advisors—often starting in their mid-40s, they’ve already lost decades of potential compounding. “So often advisors aren't talking to people until they’re in their mid-50s and starting to think about retirement,” says Stuart. “By then they’ve lost 20 years.”
Clients can give advisors discretionary management over their HSAs just as they can with IRAs, and they can bill for their work on an AUM-fee basis. Brandywine currently offers the service without charge, but Henley and company are considering changing that. If the firm decides to charge an AUM fee it would likely be drawn from a taxable client account, Henley says, to maximize the HSAs’ tax-free compounding. It’s the same way the firm charges for managing Roth IRA assets.
There’s a compelling fiduciary argument that advisors should be pointing clients to the medical-IRA strategy even if it doesn’t move the revenue needle much. Advisors already help clients optimize Social Security timing and navigate Medicare choices. With medical costs in retirement high and rising, advisors should give clients a leg up through education about and implementation of long-term investment strategies within HSAs, Henley says.
Stuart thinks smart advisory firms should offer free education about the strategy within workplaces, an approach that over time could yield a crop of clients with retirement assets as well as HSA assets to manage.
A final hesitation many high earners may have when it comes to funding medical IRAs has to do with unspent funds. If an account holder dies with a balance, the account is transferred to a surviving spouse tax-free. But upon the survivor’s death, beneficiaries receive a distribution that’s considered taxable income. It’s something Stuart has thought about.
He assumes he and his wife will have more than $300,000 of medical expenses in retirement. He has about half that amount in his HSA, and barring a major unexpected expense, the account will be emptied during their retirement, he says. If Stuart dies early, the remaining funds will go to his spouse tax-free to spend down. If she dies with an unused balance, the couple’s four children will receive it as taxable income. But Stuart isn’t concerned. “I don't worry about that any more than I worry about dying with too much money left in my IRAs,” he says.