How to choose the best health savings account

It is estimated that the average American couple will spend in the neighborhood of $300,000 on health care costs in retirement. Health savings accounts are a great way to prepare for those expenses as well as pay for immediate medical expenses. HSAs are tax-advantaged accounts available only to people with high-deductible health plans, to help them pay their out-of-pocket medical expenses now or later.

“They are growing in popularity like crazy, 25 percent a year,” says Leo Acheson, CFA, a director in manager research at Morningstar Inc., a Chicago-based global investment research firm. “But they are still under-utilized.”

If you’re considering a health savings account, here is what you need to know about finding the right one for you.

What is a health savings account?

A health savings account is a tool for saving or investing for the purpose of paying out-of-pocket medical expenses. To qualify for an HSA, you must have a health insurance plan that meets the high-deductible figure set by the Internal Revenue Service. For 2020, a qualifying insurance plan has a deductible of at least $1,400 for an individual or $2,800 for a family.

The tax benefits of HSAs are better than even 401(k)s, traditional IRAs, Roth IRAs and 529 college savings accounts. “They are unrivaled in the tax code,” Acheson says.

HSA tax benefits include:

  • Contributions are tax-free, up to the limits set by the IRS.
  • The interest earned is tax-free.
  • Withdrawals are tax-free as long as they’re used to pay for qualified medical expenses.

“With health savings accounts, you get triple tax benefits,” says Dan Mathews, a private wealth manager at Creative Planning in Overland Park, Kansas. “It’s really the holy grail of savings accounts.”

If you spend HSA funds on something besides medical costs, you’ll pay income tax on that amount, plus a 20 percent penalty. If you’re 65 or older, you’ll owe the tax but not the penalty.

How a health savings account works

Annual contributions to HSAs are limited. For 2020, the maximum allowable contribution for individuals is $3,550; $7,100 is the maximum contribution allowed for those with family coverage. If you are 55 or older at the end of the year, you can contribute another $1,000.

There are also out-of-pocket maximums for high-deductible health plans. In 2020, the most an individual has to pay out of pocket is $6,900; for a family, it’s $13,800.

HSAs provide a lot of flexibility. The accounts often come with debit cards, which makes paying for medical expenses easy. They’re also portable, so if you change jobs or retire, you still have access to your HSA.

An HSA works differently from a flexible spending account. With an FSA, you must spend the money by the end of the plan year, or lose it. HSA money is yours until you spend it. The unused balance rolls over year after year. And unlike traditional IRAs and 401(k)s, you are not required to start taking distributions at a certain age.

There are employer-sponsored HSAs and there are ones offered by banks, credit unions, insurance companies and other financial institutions. If your employer offers one, you’re not obligated to choose it; you can do your own research and pick the HSA you like best.

If you decide to shop for an HSA, here is what you should consider.

How to choose a health savings account

Morningstar’s 2019 assessment of the HSA landscape found that information about account fees, interest rates and other relevant details can be hard to pin down. “With certain providers, it’s hard to find even the most basic things on their websites,” says Acheson, co-author of the Morningstar report, which notes that transparency on HSAs is “subpar.”

Here’s what you should look out for when shopping for an HSA.

Decide how you will use the account

Before choosing an HSA, consider how you’re going to use it. Do you plan to use your HSA as a short-term spending account for medical expenses as they arise? Or do you plan to focus on saving and investing so that the funds in your HSA can be used in the distant future?

How you intend to use your HSA will determine which factors carry more weight in your decision.

Watch out for fees

HSA fees “vary drastically,” Morningstar found, and there can be a long list of them. There are maintenance fees, investment fees, paper statement fees and per-transaction charges. Some HSAs charge a fee to open the account, obtain, replace or renew a debit card or transfer money from a savings account to an investment account. HSAs may also have overdraft fees or non-sufficient funds fees.

Regardless of whether you plan to spend your HSA on medical expenses as they arise or invest it for retirement, the fee factor is key when comparing your options. “Fees tend to be the biggest differentiator among plans,” Acheson says, noting that in the current low interest rate environment, fees can have an overwhelming impact on earnings.

Always ask for a complete schedule of fees before you make a decision.

Inquire about minimum balances

HSAs often don’t require a minimum balance, but some administrators waive fees if the account balance is high enough. Ask whether the waiver is based on a minimum savings balance or a combination of a savings and investment balance.

If you want to invest your HSA, ask whether there is an investment threshold. Morningstar found that most of the HSA investment providers it studied require investors to keep $1,000 or $2,000 in a checking account before they can invest.

“Certain providers require you to keep a certain amount of money in a checking account before you can invest in the market,” Acheson says. “They want you to have money there in case you need it for healthcare costs.”

Compare interest rates

Like standard savings accounts, HSAs offer an opportunity to earn interest. But given the current interest rate environment, yields these days are not particularly high. Morningstar found that checking account yields on HSAs are “depressed” overall, with APYs ranging from 0.01 percent to 1.07 percent.

Some HSA custodians offer account holders the chance to earn a higher yield through products that are not FDIC-insured. You would have to consider whether that’s a risk worth taking.

Make sure the account is easily accessible

There are benefits to setting up your HSA through your employer or going with the provider recommended by your health plan. With an employer-sponsored HSA, for example, your company might make contributions to your account. You can also specify how much of your paycheck you want to sweep into your HSA.

If convenience is important, another option is to go with an HSA provided by your bank or credit union. That way, you’re managing your HSA and checking or savings account through the same financial institution.

It’s best to shop around to make sure you find an account that suits your goals.

Make sure investment options are diverse and strong

Some HSAs are just savings accounts while others feature an investment option. If you want to invest your savings, consider the types of investments that are available. HSA custodians offer a mix of mutual funds, stocks, bonds and other investment products.

Morningstar recommends looking for HSA investment accounts that:

  • Charge low fees for both active and passive investing strategies
  • Offer strong strategies in all core asset classes
  • Limit overlap among investment options
  • Avoid investment thresholds that require investors to keep a certain amount of money in a checking account before they can invest.

Remember, investing in risky products may mean that your money is not there when you need to pay for a service. Unlike bank deposits, stocks and other investments are not insured by the Federal Deposit Insurance Corp.

Savers, stick with a federally insured bank

If you plan to keep your HSA in a spending account, make sure the bank or credit union you choose is insured. At banks, the FDIC insures deposits up to $250,000 per depositor, per insured bank, for each account ownership category. At National Credit Union Administration credit unions, your money is insured up to $250,000 through the National Credit Union Share Insurance Fund.

If your financial institution fails, you will still get your money back.

Evaluate the customer service

Make sure the bank, credit union or other HSA custodian answers all your questions and provides you everything you need to know to make informed choices. Check on customer service hours and ask about tools that can help you track and manage your account, such as mobile apps with budgeting features. Some financial institutions offer helpful online tutorials. If you prefer to visit the bank, ask about branch locations and hours and ATM availability.

Best health savings accounts

In 2019, Morningstar evaluated 11 HSA providers, 10 of which offer investment options. HSAs were assessed based on fees, interest rates, investment strategies and other factors. Morningstar concluded that Fidelity offers the best HSA plan for both spenders and investors.

Top HSA Plans for Spenders Top HSA Plans for Investors
Fidelity Fidelity
Lively The HSA Authority
The HSA Authority Bank of America
HealthEquity Further
HSA Bank Fifth Third

You may also want to check out HSASearch, a tool that can help you easily compare HSAs.

Featured image by Monkey Business Images of Shutterstock.

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