Health savings accounts (HSAs) — the magical unicorns of “tax efficiency” — have quickly become the darling of the early retirement movement, and it’s easy to see why: the money that you put into them is never taxed, ever, and it dodges several other hoops you have to jump through with other tax-advantaged accounts. For a person who’s young and healthy who can sock money away in an HSA, they can be an effective way to save for retirement health care expenses.
Here’s the thing, though: they’re not great for everyone.
In fact, they’re not great for most people, or for most stages of life.
Setting aside the question of whether HSAs are good policy, or whether they help average earners save for health care (they don’t, just like 401(k)s and IRAs don’t help average earners save for retirement), let’s focus instead on whether people with sufficient means to save for early retirement or financial independence should opt for a HSA or not.
(Spoiler: They shouldn’t.)
Quick refresher on health savings accounts: As podcasters, bloggers and various financial experts love to remind us all, HSAs are “triple tax-advantaged,” meaning the money you put into them isn’t taxed, that same money isn’t taxed when you take it out and you aren’t taxed on the gains or earnings. (Though FYI that contributions are still taxed in California, New Jersey and Alabama, making them more like Roth accounts at the state level in those places.) HSAs can be used as a savings vehicle (money kept in an interest-bearing account), or as an investment vehicle (invested in mutual funds or stocks). Anyone can contribute to your account, most especially your employer. And you can keep the account forever, without ever having to spend it down, meaning no required minimum distributions (RMDs). HSA funds can only be used for “qualified medical expenses,” which is a plenty long list that includes nearly everything you’d think of as health care expenses, but it does not include the most common expense of all: health insurance premiums. Of course, to be eligible to save in a HSA to begin with, you must first be enrolled in a high-deductible health plan (HDHP), something the law defines as greater than $1,000 per person, but the plan must specifically be designated as an HDHP to count.
And that, friends, is where the problem lies. Just like the problem with the 4% rule isn’t the 4% rule, the problem with the HSA isn’t the HSA. The problem is the deductible.
The Devil’s In the Deductible
Insurance deductibles are a big deal, and not just because they tell you how much you are on the hook for before insurance will kick in. But because they’re also a huge predictor of behavior, in this case negative behavior that can have lasting impacts. I’ll get to that, but for now just go with the idea that big deductibles are a problem.
On the surface, the HSA rules seem to solve the problem a deductible might cause by giving you a triple tax-advantaged way to pay that deductible. A HDHP is defined as having “only” a $1000 deductible, and the current HSA contribution limit per year is far greater than that, at $3,450 for an individual, or $6,900 for a family. Neat! (Assuming you are diligent about saving that, anyway.) But the law’s definition and reality have diverged significantly in recent years. Currently, very few plans have such low deductibles anymore. Our non-HDHP PPO plan has a $5000 deductible, and that’s not considered “high.” In fact, most deductibles for high-deductible plans are now higher than the HSA contribution limit. Kaiser Family Foundation data show that deductibles are rising almost six times faster than wages, and 10 times faster than inflation.
Take, for example, the deductibles for the HDHPs available on Covered California, the largest state exchange:
The plans are cheap (I’ve plugged a $50,000 annual income into the calculator to get these premiums, but the deductibles aren’t tied to income), but the deductibles are significantly higher than the HSA limit — by almost $3,000 in a year for a family.
If you can afford to cash flow your health care costs without dipping into your HSA, because you intend to let the HSA funds grow instead of spending them, or if you use a high-deductible plan with the intent of not using much health care, none of this may seem like a big deal. But it is. Because: research finds that people with high-deductible plans don’t use the free, preventive care they’re guaranteed by law. And they put off other care that they actually need, which can have detrimental effects. The idea behind HSAs was to make patients consumers, and give us more skin in the game to control health care costs. But turns out, we’re pretty lousy health care consumers. Even the smartest, richest ones among us.
According to Kaiser Family Foundation, “High deductibles have actually forced people to delay care that could prevent health emergencies later or improve their quality of life.” A UC-Berkeley and Harvard study concluded that “people with high-deductible plans spent 42 percent less on health care before meeting their deductibles, primarily by reducing the amount of health care they received, not by shopping around for a better price.” [emphasis mine]
According to a study published in the Quarterly Journal of Economics that looked at consumer behavior after switching from a traditional plan to a HDHP with HSA, and written in the artful prose only economists master, “We find no evidence of price shopping in the first year post-switch. We find no evidence of an increase in price shopping in the second year post-switch; consumers are not learning to shop based on price. Instead, we find that essentially all spending reductions… are achieved through outright quantity reductions… whereby consumers receive less medical care. These quantity reductions persist over time.” (Translation: Rather than try to get the best deal on care, people just get less care, and that’s not just while learning the ropes of the new plan.) They add, “A meaningful portion of all spending reductions came from well-off consumers who were predictably sick, implying that the true marginal prices they faced under high-deductible care were actually quite low.” (Translation: It’s not just poor and middle income people who reduce care in the face of a high deductible.) Finally, they confirm, “Despite the fact that preventive services are free both before and after the switch to high-deductible care, we find that consumers meaningfully reduce consumption of these services.”
That’s multiple, credible studies that conclude that high deductibles make us all avoid getting health care, including the preventive services like checkups, immunizations and screenings that are free. It’s not hard to see why that’s a problem: you’re putting off treating something until it’s more serious, when it might be harder and more expensive to treat, and you’re missing out on the opportunity to be diagnosed early for something that could be impossible to treat if not caught early on.
This is not something that just affects people who struggle to pay, as the economists show. It also affects those who just don’t want to pay, which likely describes every financial independence-focused person. If the doctor visit you might once have paid $20 for is suddenly $100, $150 or maybe entirely a mystery because you don’t actually know what a doctor visit costs with insurance kicking in nothing, that’s a very different proposition. It’s why, according to Kaiser, “studies dating to the 1970s have consistently shown that when consumers must spend a big chunk of their own money on their care, they can cut back by as much as 15 percent. That slowdown happens fast, dropping like a health care guillotine.”
Consider the story of Ashish Jha, a physician and Harvard health policy researcher. To understand the question of what happens psychologically when patients take on a higher share of the costs of a given medical encounter, he switched himself and his family to a high-deductible health plan, with a $6,000 deductible. Not long after, he experienced a racing heart that he couldn’t settle, something he knew very well could lead to a heart attack. But rather than go to the hospital — and have to pay that deductible — he decided to just hope for the best instead.
His wife asked what he’d recommend if a patient called with the same problem. “I said, ‘Oh, that’s easy.’ Go to the emergency department.”
This is a doctor who studies health policy and health care decision-making at Harvard who made what he readily admits was a very dumb choice in the interest of an amount of money that would seem so trivial if he had had a heart attack or died over it. The one and only upside is it gave him insights to use in his research into the impact that high deductibles have on our health care decision-making.
More from the story:
“What I take away from [his] story,” said Amitabh Chandra, a friend and fellow Harvard health policy economist, “is that simply calling the patient a consumer doesn’t make buying health care anything like buying cars and computers.”
Last year, Chandra and three colleagues looked at what happened after a Fortune 100 company switched 75,000 well-paid, tech-savvy employees into high-deductible plans. What they found closely mirrored Jha’s personal pattern.
Workers — both the healthy and the sick — skipped out on care indiscriminately. “Prevention, imaging or drugs, consumers were cutting back on all those,” Chandra said.
“That’s a sign they don’t really know what care is valuable and what care isn’t valuable.”
High-deductible supporters argue that consumers need time to adapt and more tools that will help them price-shop effectively.
The researchers considered that, too. The company put $3,750 into a health savings account for each employee and provided a state-of-the-art online tool to compare prices for tests, doctor’s appointments and other services. “We found no evidence that consumers were learning to price-shop after two years of high-deductible coverage,” Chandra said. “None.”
“They don’t really know what care is valuable and what care isn’t valuable.” That line should humble all of us. We’re trained to think we’re savvy consumers, and we assume that we can translate that skill to managing our own health. But it turns out we can’t.
And in the face of high deductibles, we increase our chances of cutting out care that’s actually necessary because we assume we can tell what care will actually help us and what care won’t. Even when we’re comfortable financially. Even when our HSA is well-funded. Even when we’re smarter than average. Even if we’re sick and know we need care.
High deductibles make smart people do dumb things.
Consider Your Own Situation Carefully Before Opting for a HDHP and HSA
The research on deductibles should give everyone considering a HDHP over a traditional comprehensive insurance plan pause. But there’s more to consider beyond just the (massive) psychological barrier that the deductible poses.
For example, investment options are more limited with HSAs than with other tax-advantaged accounts, and they most often come with significantly higher fees than your 401(k). (You remember what fees do to your gains, right?) According to Morningstar, “Health savings accounts are a very under-researched corner of the market. Investors have few resources available to help them navigate the hundreds of plan providers that exist.” If you wish to invest your HSA funds instead of simply saving them, you’ll likely face trading fees and investing fees on top of management and fund fees, and not a lot of help to track down lower fee funds.
In addition, most people trying to use HSAs for their tax advantages will likely want to invest the money they sock away, not just put it in a savings account. And then you run into the same problem you have with any investments: they might be doing badly when you need that money. But unlike other investment accounts, you can’t easily optimize the timing of when you sell shares or convert from one vehicle to another. You can only use that money to pay directly for medical expenses, so at best you can only hope that your big expenses will occur when the markets are up.
Of course, there are those tax benefits, and for some that will be the deciding factor, no matter how much research I throw up here about how high deductibles harm our decision-making ability. And that’s fine. Do what’s right for you. But actually think through your situation and your own tendencies before you go for the HSA option.
And consider perhaps the most salient point of all from a personal finance perspective: experts who’ve analyzed this stuff say that, considering all factors, most people come out ahead on a traditional health insurance plan with a lower deductible, not an HDHP with HSA. That’s before you assign a value to your health and factor that in.
While high deductibles might be fine for homeowners or car insurance (which are true insurance, because your intent is not to need them), they are bad for your health.
If you have a choice between a traditional comprehensive plan with a manageable deductible, and a high-deductible health plan with a deductible that makes you not want to go to the doctor, opt for the lower deductible option, even if it comes with a higher monthly premium.
Of course, if your only health insurance plan option is one that qualifies as a HDHP, then by all means take advantage of the HSA! If your employer offers a match, do just as you would with your 401(k) and save at least enough to get the match. (Free money! But not free money that outweighs a lower deductible.)
If you’re in your 20s, have no dependents and are completely healthy — and your employer kicks in at least $1000 toward your HSA — then experts say you could come out ahead rolling the dice on health care expenses, but only if you can afford to pay for the full cost of your out-of-pocket maximum, which is often only a bit higher than the deductible because it’s capped by law.
And even then, think of the HDHP as a temporary approach that will allow you to sock some money away in an HSA for a few years before switching to more traditional insurance.
In any other circumstances, do all the math before you go with a high-deductible health plan just because the HSA comes with those magic-sounding words, “triple tax-advantaged.” It could be quintuple tax-advantaged and it still wouldn’t make sense for everyone.
And no matter which choice you make, use your free preventive care!
What’s your take on HSAs? Do you have one? Are you considering switching to a high-deductible plan to get access to an HSA? Have you had an HSA and made the switch to a more expensive but lower deductible plan? Wherever you land on this stuff, we’d all love to hear your perspective. Share away!
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Categories: we've learned