The $100 billion health savings account (HSA) industry offers some significant financial planning opportunities for advisors and their clients, as only about a third of industry assets have been invested, an HSA specialist said.

As of the end of 2021, there were some 32 million HSA accounts in the U.S., with more than $100 billion in assets, said Peter Stahl, founder of consulting firm Bedrock Business Results in Wayne, Pa., and a certified financial planner and healthcare specialist. However, only $34 billion of that has been invested.

“That’s a lot of money sitting in cash out there,” he said during a presentation at Schwab Impact 2022 earlier this month. “This breaks down into two categories: those that I call accidental accumulators and those who are doing deliberate planning.”

Deliberate planners, he said, are recognizing how these accounts can be used, and who are getting advice from an advisor. “And what is happening there is tremendous.”

Increasing healthcare costs are driving growth in HSA usage, Stahl said. By 2021, the average annual premiums for employer-sponsored health insurance had risen to $7,739 for a single person and $22,221 for a family, he said.

“Not only is it very expensive, but the price increases have been crazy,” he said, noting that family coverage has increased 22% over the last five years and 47% over the last 10 years. “This is one of the biggest challenges that we face when it comes to saving and investing money as a nation.”

Several other important savings buckets—like retirement, a home purchase, or college education, or all three—get moved down the priority list because of the cost of healthcare, he said. Health plans with high deductibles (and lower premiums) have brought some relief, but the real benefit to consumers that can accompany qualifying high-deductible plans is the use of health savings accounts.

They’re not a universal solution, Stahl said, as some consumers need first-dollar coverage based on the state of their health and not all insurances are qualifying. But for those clients who can use one, an HSA is a tax-advantaged savings and investment account used for medical expenses.

To qualify for an HSA, family medical coverage needs to have at least a $2,800 deductible with a $14,100 maximum for annual out of pocket expenses, and individual coverage needs at least a $1,400 deductible with a $7,050 maximum for out of pocket expenses.

For this year, contributions limits are $3,650 for individual coverage ($3,850 for 2023) and $7,300 for family coverage ($7,750 for 2023). In addition, there’s a $1,000 catch-up provision for account holders 55 years old and older.

The ways HSAs are tax-advantaged start with contributions going in through payroll deductions before federal, state and FICA taxes are applied. The earnings—interest, dividends and capital gains­—grow tax free. And then withdrawals for healthcare expenditures are also tax free.

“If you’ve been around this industry for a while, you know there’s not a lot of those triple tax-free plans left where you get the deduction going in, without any income limits, you get tax-free growth, and then you can pull the money out, income tax free,” Stahl said. “You should never have a taxable distribution from an HSA.”

There is a penalty for making withdrawals for non-medical expenses in that the withdrawal would be taxed, and there’s 20% penalty on a withdrawal for account owners under 65.

The trick to using an HSA for wealth building is to fund the account to the maximum possible, invest for growth, use other funds to pay for medical costs, and then use a look-back allowance to spend down those HSA dollars at a much later date after they’ve generated additional wealth, Stahl said.

For example, he said, a client who today begins fully funding a family HSA at age 50, takes advantage of all contribution increases and the $1,000 catch-up starting at age 55 and invests the account at an 8% return will have accumulated $383,000 by age 67. This includes the spouse opening an account in their name at age 55 for their own $1,000 catch-up. (A client who did this in 2004 and invested in the S&P 500 would have had an account that grew to $477,000 by the end of 2021.)

To use the HSA as a wealth accumulation vehicle, the client would cover qualified medical expenses with an emergency fund, letting the HSA funds grow untouched, Stahl said. That’s possible with an HSA because of a look-back allowance. When it’s time to withdraw funds, a client can file claims with receipts going back to the start of the account.

Qualifying expenses include vision care, dental work, hearing aids, prescription vitamins, medically necessary home modifications, Medicare premiums (parts A, B, C and D) and long-term-care insurance premiums. Of course, current expenses count, but so do prior expenses from the beginning of the HSA.

For example, Stahl said with his own twins, who needed their wisdom teeth out, the dentistry bill came to over $5,000.

“As tempting as it was, I didn’t touch the HSA to pay for it. I pulled money out of my emergency fund. I now have a $5,000 receipt sitting in my HSA folder, and I can use that $5,000 tax-free withdrawal at any point from my HSA,” he said.

Aside from wealth accumulation, there are other financial planning opportunities that go along with an HSA account, Stahl said:

• When the account owner dies, the HSA, like an IRA, can pass to a spouse who can continue to use it. If the beneficiary is a non-spouse (a child, for example), the beneficiary has 12 months to make any overlooked tax-free withdrawals on behalf of the account holder, including Medicare premiums.
• Long-term-care insurance premiums can be reimbursed out of an HSA up to certain limits: In 2022, someone age 40 or younger could deduct $450; 41 to 50, $850; 51 to 60, $1,690; 61 to 70, $4,510; and 71-plus, $5,640.
• While regular medical insurance premiums are not considered an eligible expense, there are some exceptions. COBRA premiums, premiums paid while receiving unemployment compensation, and Medicare and other healthcare coverage for clients 65 and older.
• FSAs and HSAs are compatible if the FSA is limited to vision and/or dental benefits.
• An HSA for a non-dependent adult child who is still on the family health plan can be opened in the child’s name and funded by the parent.
• There is a limited opportunity to fund an HSA with an IRA, in that the HSA contribution limits have to be met and this can occur only once in the account holder’s lifetime.
• Clients who plan on switching to Medicare (or starting social security, which automatically starts Medicare) will have to halt their HSA contributions. However, when they start Medicare they will have a retroactive withdrawal for their Medicare premiums going back six months even though they were covered by an employer’s health plan. So clients should stop making contributions to their HSA six months before going on Medicare in order to take advantage of this lookback.

To maximize both savings and investment potential, when working with a client with a 401(k) with an employer match, advisors should follow a specific order of investment, Stahl said.

“By all means, fund the 401(k) as the top priority. Utilize the match,” he said. “Once you get the match, go ahead and fund the HSA. And then if you have additional discretionary dollars, go back and finish funding the 401(k).”