How to Find the Best Health Savings Account

Ivanna Hampton: Welcome to Investing Insights. I’m your host, Ivanna Hampton. Health savings accounts offer a tax-efficient way to save for medical costs. Every year, Morningstar analyzes the HSA landscape and rates top providers. And we’ll hear from the lead researcher later in the show. But first, I’ll talk with Morningstar, Inc. editor Margaret Giles about what you should know about HSAs and how to maximize their tax benefits. Margaret has co-written Morningstar’s Guide to HSAs, and she’s here with me now as I pivot.

Thank you for being here, Margaret.

Margaret Giles: Happy to be here.

What Is an HSA?

Hampton: You have coordinated Morningstar’s HSA coverage on Morningstar.com for several years. This year’s guide looks great. I want to get into what is an HSA and how does it work?

Giles: Right. So, it’s important to know the basics before we get into the ratings down the road, right? HSAs are tax-advantaged accounts that let you save for medical costs. And there’s two sides of them. There’s the spending account side, which basically acts like a checking account where you put money in and then you can take money out to pay for qualified medical expenses. But the real power of HSAs is they have this other element, which is an investing account. And so, you can do either one or both, but you can put money in and then, similar to another kind of investment account, you can put your money in and then choose from a menu of funds to actually invest your money and have that money grow so that you can use it down the line.

Who Is Eligible for an HSA?

Hampton: How do you know if you’re eligible to have an HSA?

Giles: HSAs are only available if you have a high-deductible healthcare plan. And then, a couple of other rules there. You can’t be a dependent on someone else’s tax return, and you can’t be enrolled in Medicare. But the high-deductible healthcare plan is the main limitation there.

HSA vs. FSA

Hampton: The spending part sounds pretty similar to a flexible spending account, or FSA. How are these two different?

Giles: There’s actually some confusion. I think people tend to underuse HSAs because they think that they’re subject to the limitations of flexible spending accounts. But actually, with a flexible spending account, you are limited in the amount that you can actually roll over. It’s kind of a use it or lose it situation where you are funding it upfront, you decide I’m going to put X number of dollars in, and then once you hit the end of that period, you can only roll over a limited amount. And so, you have to really be careful about how much you’re putting in.

With an HSA, however, you keep it no matter what. You could change employers. You could hold on to that money for multiple years and never spend it. You’re going to hold on to it the whole time. Again, the other difference here is that there’s some restriction on who can have an HSA. With an FSA, no matter what type of healthcare plan you’re in, you can have one, versus HSA, again, high deductible only. But the main difference is you get to keep that money. So, that’s on the spending side. And then HSA has this whole other element of the investing piece of things.

How to Maximize the Triple Tax Benefits of HSAs

Hampton: That’s some good information to know as open enrollment is about to begin for a lot of people. I often hear about the triple tax benefits of HSAs. Can you talk about what those are and how can someone maximize them?

Giles: This is the big benefit of HSAs. So, money goes in tax-free, it grows tax-free, and then you can take that money out tax-free if you’re paying for qualified medical expenses. So that’s everything from co-pays to going to the dentist to medications. And there’s a whole long list. The IRS has it. Morningstar also has a list of expenses that you can count toward your HSA.

But the main way that you maximize an HSA is, again—I’ve kind of started to harp on it already—the investing side of things. So, to properly take advantage of the tax-free growth, you want to give your money an opportunity to grow. And so, if you invest it and you don’t take the money out and have that long time horizon, you can basically take advantage of this tax-free compounding as long as you want. There’s no mandatory distributions that you have to take. You can wait as long as you want for your money to grow. If you use it just as a spending account, you get a little bit of growth, too, but it’s just not as much, right? It’s a low interest rate that’s paid on those accounts.

How Do HSAs Compare With Other Tax-Advantaged Accounts?

Hampton: Let’s get more into the investing part. How do HSAs compare to other tax-advantaged accounts like 401(k)s and IRAs?

Giles: It’s similar in that you’re funding it, and then you’re investing, right? But with those other tax-advantaged accounts, you basically get two of the three tax benefits. So, with a traditional 401(k) or IRA, the money is going in pretax, and it grows. But then when you take it out in retirement, you have to pay income tax. And then with Roth, it’s basically the opposite where money is going in that’s already been taxed and then it grows tax-free, and you get to take it out tax-free. So, you get two of the three. HSA is the only account that gets all three of those tax benefits.

But another similarity is that there are some penalties involved if you either take early withdrawals in the case of IRAs or 401(k)s or you pay for nonmedical expenses, nonqualified expenses. So, on the IRA or 401(k) side, if you take money out before 59½, you’re going to pay an extra 10% tax penalty in addition to having to pay your regular income tax. And then on an HSA side, it’s actually a 20% penalty for nonmedical expenses until you hit 65, and then there’s actually some more flexibility.

Can You Save Too Much in an HSA?

Hampton: It may be hard to figure out how much you may need for medical costs in the future. Is it possible to save too much, Margaret, in HSA?

Giles: That is an important question. So, it’s kind of a “yes, but.” There are a lot of escape valves that an HSA offers where you don’t feel like you’re going to be hard-pressed to spend that money. So, you’ve got a couple things you can do.

The first one, which I personally think is a great, almost kind of workaround is, if you save your receipts for your any medical expense, you can actually reimburse yourself years down the line. There’s no time limit, right? So, I could have a medical expense that I incur as long as you already have the HSA, if you incur it now, I could just pay for that expense out of pocket, but if I save the receipts, I can actually take a distribution 30 years down the road, and I can still kind of count that as a qualified medical expense and not have to pay any penalty. And so that’s really good if you have a sudden emergency expense that’s non-medical-related, maybe there’s a home improvement—you have to fix your roof at some point. You can take money out of your HSA as long as you’ve kept the receipts and show that you’ve paid out of pocket for those medical expenses. That’s one escape valve where you’re not just paying for medical expenses there.

Another one is if you save your HSA until retirement, after age 65, you no longer suffer a tax penalty if you pay for nonqualified medical expenses. This is an important one, and you basically are just taxed as income. So, similar to taking a regular distribution from a traditional IRA or 401(k), you’re just going to pay the income tax. You’re still not paying any taxes on the growth of your investments. And so, that’s another way.

The last thing, though, where the reason I said “yes, but” is that you don’t really want to leave behind your HSA. This is where beneficiaries become important. If your spouse is your beneficiary, they can use the HSA after you die—sorry to talk about death here—but after you die, and they can continue to use the HSA and get the tax benefits. If your beneficiary is someone else, they actually lose all the tax benefits. They have to pay. Any money they take out, they have to basically treat it like it’s been fully taxable. They’re paying taxes on the growth and the distribution. Really, if you want to take full advantage, you want to make sure that that money is getting used. So, if you save an inordinate amount of money in an HSA, you can run into some problems, but otherwise, you’ve got some escape valves.

Hampton: All those are important to know and yes, it’s OK to talk about death because it’s a part of life. An HSA offers a lot of benefits, but not all HSA providers are the same. You talked to the lead researcher on Morningstar’s latest HSA landscape report about this year’s best HSAs for spending and saving. Can you give us a preview because the conversation is coming up in this episode.

Giles: Absolutely. I talked to senior manager research analyst, Greg Carlson, with Morningstar Research Services, and we talked about the landscape at large and then the top-rated providers, talked about if there’s any differences. So, stay tuned for that.

Hampton: Well, everyone, we’re going to check out that conversation, and after that, we’ll be back with Margaret to discuss some more about HSAs.

How Has the HSA Landscape Evolved Over Time?

Giles: How has the landscape of HSAs evolved over time?

Greg Carlson: Assets have grown substantially since HSAs were introduced back in the 2000s. There’s also been a round of industry consolidation more recently from 2019 to 2022. The good news is fees have gone down. Annual maintenance fees which typically run $25 to $45 are increasingly being waived at lower and lower balance amounts or being eliminated completely. For example, seven of the 11 HSA providers that we covered in the paper this year do not charge any sort of maintenance fee.

It’s also worth noting that there are often investing fees that are part of the bargain in addition to the fees charged by the underlying funds that you invest in. Those are increasingly going away, too, although at a slower rate.

HSA Adoption Growth and the Rise of High-Deductible Healthcare Plans

Giles: It feels like there’s been greater adoption of HSAs since they were founded 20-some-odd years ago. Has the adoption of HSAs gone hand in hand with more people being covered by those high-deductible healthcare plans?

Carlson: Very much so. Over the past 15 years, for example, we’ve gone from having less than 5% of workers in high-deductible healthcare plans to almost one third. And in the meantime, HSA assets have increased by almost twentyfold over that span.

How Does Morningstar Assess HSAs?

Giles: That’s some amazing growth. I mentioned Morningstar has this report coming out on the HSA landscape, and Morningstar rates those HSA providers every year. What goes into those rankings?

Carlson: We rank providers on two use cases. One, the spending account where you save your money in a money-market-like account and get paid an interest rate, but also as investing accounts. That’s where you’re accessing that menu of mutual funds or ETFs and holding on for a longer period probably. Fees are a very important part of the ratings, but we also evaluate interest rates offered as well as investment menu quality among other factors.

What Makes a Good HSA for Spending?

Giles: Let’s start with that spending use case. What makes a good HSA looking for someone to use their HSA as a spending account to cover those current costs?

Carlson: What you want is you don’t want any fees eat into your savings, and you want a competitive interest rate so that your money grows.

Top 3 HSA Providers for Spending

Giles: When we look at the rankings, who’s in the top three?

Carlson: Standing alone at the very top is Fidelity. That’s the only provider to earn our highest rating as a spending account. They don’t charge any fees, and they pay what is far and away the highest interest rate in an FDIC-insured option. There are half dozen other providers that earn an Above Average assessment. Most of those don’t charge a maintenance fee, either, but their interest rates are often pretty low. First American Bank offers the best interest rate among that group.

Giles: So, it sounds like Fidelity, at least in this use case, is really kind of a cut above the other providers.

Carlson: Definitely.

What Makes a Good HSA for Investing?

Giles: Let’s pivot a little bit to the investing use case. What’s the most important there for someone who’s looking for an HSA that they can invest and use down the road?

Carlson: gain, low fees here are really important. Also, a well-designed investment menu with high-quality offerings that’s really essential. We think that high Morningstar Medalist Ratings are a strong indication of quality. And ideally, a provider won’t require a certain minimum spending account balance before you can start to invest.

Top 3 HSA Providers for Investing

Giles: What are the top three when it comes to the investing use case?

Carlson: Here again, Fidelity earns the only high assessment. It charges no investing-related fees. You only pay the expense ratios of the funds that you invest in. Its investment menu is also one of the better ones out there.

Going further down the list, there are several that earn an Above Average rating. HealthEquity earns the second-best overall score. Its investment options are cheap and of high quality. I would also mention here NueSynergy, which is a new one in our paper. It’s a provider that’s expanding the reach of its plans. They have the most inexpensive investment menu, and it consists of high-quality exchange-traded funds. Most of those have Medalist Ratings of Gold.

Giles: So, it seems like Fidelity again is kind of at the top. But at least in this investing side of things, there are some close competitors there.

Carlson: Yes, there are. There are.

Giles: Well, I feel like we’ve covered a lot of ground from the basics to the landscape to the ratings. Thanks for being here today, Greg. I really appreciate it.

Carlson: Thanks for having me.

Morningstar’s Guide to the Best HSA Providers

Hampton: Well, Margaret, great conversation with Greg. I really enjoyed it. I did want to ask you before we wrap up today’s episode, what will the audience find in Morningstar’s guide—and I want to get the name right—The Best HSA Providers?

Giles: Yes, absolutely. So, our guide is basically a one-stop shop for HSA information. So, it covers the basics like what we talked about, common questions like, what are the contribution limits for this coming year and then it also gets into the ratings. So, it has the full set of ratings for both the investing accounts and spending accounts, and then it actually has what we think about each individual provider. So, a lot of information there. I highly recommend checking it out.

Hampton: Of course, of course, and everyone, you will find a link in the show notes. You’d want to check this out as you’re preparing for open enrollment. Margaret, thank you for coming to the table. We’ve learned a lot from you today.

Giles: Thanks for having me.

Hampton: Well, that wraps up this week’s episode. Subscribe to Morningstar’s YouTube channel to see new videos about investment ideas, market trends and analyst insights. Thanks to senior video producer Jake Vankersen, content development editor Margaret Giles, and associate multimedia editor Jessica Bebel. And thank you for watching Investing Insights. I’m Ivanna Hampton, lead multimedia editor at Morningstar. Take care.