Missed Opportunities

PLANADVISER: Please share your background and interest in health savings accounts—why is this topic important to you?

Adam Leive: I began studying health savings accounts as a doctoral student in health economics at The Wharton School. My main area of research was in health insurance markets, but I had side interests in retirement saving and personal finance. When I realized HSAs sit at the intersection of these topics, the accounts quickly became my focus. I was intrigued by the design of HSAs combined with high-deductible health plans as an innovative approach to efficiently containing the growth of health care costs. At the same time, I knew that choosing a health insurance plan or deciding how much to save is a hard problem for anyone to solve. And not only are these choices complicated, but I think most people probably don’t enjoy making them. Therefore, I was curious to learn whether HSAs could work in practice.

Since then, I’ve looked to answer various questions about how people should use their HSAs, how they use their HSAs in reality, and what can explain this behavior? I find these questions interesting because they concern important financial decisions many people make year after year. Over time, these choices have important implications for a person’s economic security and the nation’s aggregate health-care spending. [In my work] as a professor of public policy, the ultimate objective of my research is to find ways that improve the design and operation of health-care financing.

PA: Why are consumers not using their HSAs as savings vehicles as intended, and what are the implications for participants, and for the overall policy of using the funds to pay as you go?

Leive: My research suggests there are several reasons why most people don’t use their HSA as a savings vehicle. One important reason is liquidity. Many people lack other savings they can easily access without penalty to pay their deductible and copays. In collaboration with Brent Davis and Andrew Gellert at the TIAA Institute, I surveyed how 1,900 employees at 15 universities use their HSA. We also measured the employees’ financial literacy—as defined by their ability to correctly answer questions about compound interest, inflation and investment diversification—and whether they faced liquidity constraints. Then we merged their survey responses to TIAA’s administrative records of their retirement account balances.  

Employees who reported that they were uncertain they could finance a $2,000 emergency expense or who had an outstanding retirement-account loan made lower HSA contributions, had lower HSA balances and were more likely to withdraw all or most of their HSA each year. When asked how they plan to use their HSA, these employees were less likely than those without liquidity constraints to say they planned to use it for health expenses in retirement.  

A second reason consumers use HSA funds before retirement is financial literacy. Those who correctly answer questions about compound interest, diversification and inflation are more likely to report planning to use their HSA as a retirement savings vehicle. Consistent with this stated goal, employees with high financial literacy also make larger HSA contributions, have a higher balance and are less likely to deplete their HSA while working. They are more likely to choose their contributions based on the HSA’s tax benefits.  

But financial literacy and liquidity constraints are only part of the explanation. Even many people with high financial literacy who have ample liquidity still don’t use their HSA as a savings vehicle. More than 40% of such employees who have an HSA didn’t know how their balance was invested or whether it was held in cash.  

Part of this behavior may stem from the complexity of HSAs. The rules can be complicated, and, understandably, many people don’t know the key features. For example, some may not recognize that they can use their HSA to pay for Medicare premiums and out-of-pocket expenses, or long-term care. Some may incorrectly believe that HSA balances do not roll over, although in one setting I’ve studied I found that not to be the case. Other people may perceive managing the HSA to be a hassle. 

Then there are psychological factors. Some people may view HSA money as reserved for their current health expenses, even if they recognize that the money could be used in retirement. But, from an economic perspective, a dollar is a dollar. And the best use of an HSA dollar is to let it grow to take advantage of its unparalleled tax benefits.  

People sacrifice a lot of money over their lifetime by not using the HSA as a savings vehicle. My research finds that people who receive an extra dollar in their HSA withdraw 85 cents that same year. Most funds are not saved. But paying for current health expenses from the HSA means you forego the tax deductibility of investment returns. And a smaller HSA makes it more expensive to finance health expenses later in life, since more costs must then be paid with after-tax dollars. The key to making that strategy work is to invest HSA assets. If your employer’s HSA [program] doesn’t offer good investment options or charges high fees, you may transfer those assets to a personal HSA that you prefer. 

PA: Many retirement plan advisers have an opportunity available to them, as most meet with participants either individually or in a group setting to educate them about retirement savings. How can they use behavioral strategies to help participants understand the accounts can be a type of retirement income?

Leive: The academic literature has not yet rigorously tested different strategies, but the evidence on related topics suggests the following approaches could help. 

For a significant one, visualizing the financial consequences of different decisions can transform the complexity of HSAs into terms that are easier to understand. For example, someone in the 25% tax bracket would need to save $266,666 in their tax-deferred 401(k) account in order to have the $200,000 an individual is projected to need to cover health expenses in retirement. Compare that with having a non-taxable $200,000—or at least a portion of that amount—saved in their HSA to pay for health expenses in retirement. 

These types of simplifications can help with a few challenges. First, they make it so that participants do not necessarily need to understand all the details of an HSA. Second, they help to show the importance of shielding investment returns from taxation. Exponential growth is a difficult concept, and combining exponential growth with tax benefits makes it an even harder one. Third, framing the decision as one about how much a participant would need to save today helps shift the perspective from the future to the present. The hope with HSAs was originally to get people to trade off future spending against current spending. So any strategy that makes that trade-off more salient would help clarify the savings benefits of HSAs. 

Part of the challenge is that using an HSA as a retirement savings vehicle may seem counterintuitive. Explaining other counterintuitive strategies that the adviser has previously helped educate participants about could help reinforce why this strategy works. 

For example, I suspect advisers might often discuss with participants the pros and cons of paying off a mortgage that has a fixed interest rate, early. If a participant can obtain a return elsewhere that exceeds their mortgage rate, then continuing to hold the mortgage debt can pay off in the long run. This is particularly salient given today’s high-interest-rate environment. The same logic applies to the case when a participant might have multiple sources of debt, and the question is which debt to pay down first. Paying down the debt with the highest interest rate first, regardless of the balance, applies the same logic that “a dollar is a dollar.”

Finally, one strategy I used was to cut my HSA debit card in half. Destroying the card adds a hurdle that nudges people toward using the account for retirement savings.