Don't Settle for a Subpar Health Savings Account

FILE - An emergency room sign is displayed outside Harbor-UCLA Medical Center, Feb. 24, 2021, in Torrance, Calif. (AP Photo/Ashley Landis, File)

Love them or hate them, it's hard to see health savings accounts losing traction any time soon. Used in conjunction with high-deductible healthcare plans, the accounts have been touted as a way to put downward pressure on healthcare costs.

Even though HSAs are the only triple tax-advantaged vehicle in the tax code--allowing for pretax contributions, tax-free compounding, and tax-free withdrawals for qualified medical expenses-- few HSA owners fund the accounts to the maximum.

HSA critics point out that the high-deductible healthcare plan/HSA combination is a good fit for the "healthy and wealthy" but is apt to be less advantageous for lower-income workers.

But even wealthy consumers may avoid taking full advantage of their HSAs because the HSA their employer has chosen to accompany their high-deductible healthcare plan simply isn't very compelling.

Here's a closer look at how to know if an HSA is subpar, and the best ways to get around it if it is.

Valuable Tax Advantages May Come at a Price

Based purely on the tax advantages, HSAs appear to have it all over other tax-advantaged savings vehicles, especially for investors who know they will have some out-of-pocket healthcare expenses down the line.

Yet HSA expenses and/or shortcomings on the investment front can erode the accounts' prodigious tax benefits. That's particularly true for smaller HSA investors: Not only do flat dollar-based account-maintenance fees (say, $45/year) hit smaller HSA investors harder than ones with larger balances, but interest rates for smaller investors' health savings accounts may also be lower. Thus, it's valuable to conduct due diligence on your HSA.

Be sure to assess the following:

Setup Fees: A one-time fee imposed at the time of the health savings account setup; this fee may be covered by your employer.

Account-Maintenance Fees: These are fees for maintaining your account at the institution, whether a bank or credit union; they can be levied on a monthly or annual basis. They may be covered by the employer, and HSA investors with larger balances may be able to circumvent them altogether.

Transaction Fees: These dollar-based fees may be levied each time an individual pays for services using the health savings account.

Interest Rate on Savings Accounts: Many HSAs offer lower interest rates on smaller balances than they do for larger ones; that--combined with the fact that account-maintenance fees are apt to hit smaller HSA savers harder than larger ones--argues for building and maintaining critical mass in your HSA, to the extent that you use one at all.

Investment Choices: Assess the investment lineup on offer to make sure it aligns with your investment philosophy. Many HSA investment lineups tilt heavily toward low-cost index funds, but others feature primarily actively managed funds, often with higher expenses.

How to Switch Out of a Poor HSA

If you've done your homework on your employer-provided HSA and found it lacking, you have three distinct choices.

Option 1: Contribute to an HSA on Your Own

As long as you're enrolled in a high-deductible healthcare plan, you are technically free to pick another HSA rather than steering your contributions into an employer-selected HSA.

You could then deduct your HSA contributions on your tax return. However, that's more cumbersome and requires more discipline than steering a portion of your paycheck directly into the "captive" HSA.

Additionally, HSA contributions made under a salary reduction arrangement in a section 125 cafeteria plan are not subject to Social Security and Medicare taxes, whereas those taxes will come out of your paycheck even if you ultimately end up diverting those dollars to your own HSA.

For those reasons, foregoing payroll deductions for an HSA is usually not the best option.

Option 2: Transfer the Money from Your Employer-Provided HSA into Another HSA

With this strategy, your HSA contribution is deducted directly from your paycheck and sent to your employer-provided HSA; you can then periodically transfer all or a portion of that balance into an external HSA of your own choosing.

There are no tax consequences on HSA transfers, and you can conduct multiple transfers per year.

The employee can contribute enough to the savings account to cover anticipated out-of-pocket healthcare costs, but steer any excess funds into an HSA with better investment options.

Option 3: Roll Over the Money from Your Employer-Provided HSA into Another HSA

This strategy is similar to option 2.

You contribute to your employer-provided HSA via payroll deduction, then roll over the money to an HSA provider of your choice.

There are two key differences between a rollover and a transfer, however.

The first is that in contrast to a transfer, where the two trustees handle the funds and leave you out of it, a rollover means you get a check for your balance; you must deposit that money into another HSA within 60 days or it counts as an early withdrawal and a 20% penalty will apply if you're not yet 65 (or if you don't have receipts to support medical expenses equal to the amount of your withdrawal).

Another key difference is that multiple transfers are permitted between HSAs, but you're only allowed one HSA rollover per 12-month period.

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This article was provided to The Associated Press by Morningstar. For more personal finance content, go to https://www.morningstar.com/personal-finance

Christine Benz is the director of personal finance and retirement planning at Morningstar.