Investment choices in HSAs expanding

NEW YORK — When banks and brokers first started offering health savings accounts, clients could choose any investment they wanted for their account funds — as long as it was a certificate of deposit.
But that is changing, according to industry observers, and the result may be increased use of HSAs as tax-advantaged savings vehicles by wealthy clients who don’t need the accounts to pay medical expenses.
HSA providers spiced up their investment choices in 2006, and even more options are on the way in 2007, according to a white paper due to be released next month by Financial Research Corp. in Boston (see the white-paper chart, which was provided by FRC as an exclusive to InvestmentNews).
“The world is the investor’s oyster with HSAs, because any investment vehicle available to individual retirement accounts is available to HSAs,” said Lynette DeWitt, FRC’s associate director of retail investment markets, who is conducting research for the white paper.
Most of the growth is coming in the form of a variety of mutual fund offerings — about 200 total funds now are available through various platforms — and self-directed brokerage, she said. Real estate, startups and other alternative investments also are available, Ms. DeWitt added.
HSAs that offer self-directed brokerage — already a favorite option for the wealthy — should prove especially appealing, observers noted.
Self-directed brokerage also is popular with advisers.
“I have an account with HSA Bank [in Sheboygan, Wis.], which has self-directed brokerage through [TD] Ameritrade [Holding Corp. in Omaha, Neb.],” said Andy Midkiff, a portfolio manager with Clearpoint Capital LLC in Fairhope, Ala. “I have access to whatever investment vehicle I choose,” he added.
With self-directed brokerage, the wealthy clients even can invest in exchange traded funds, said Robert Ellis, a senior analyst in the wealth management group of Celent Communications LLC in Boston.
“It may also be possible to invest in hedge funds, if the balance is big enough,” he said.
An obstacle that has held back growth in HSA investment options is that the average account balance has been low — $2,500 to $3,000 — according to Eric Remjeske, co-founder of Devenir Group LLC in Minneapolis, which develops HSA investment platforms.
Many mutual funds have minimum investments of $1,500 to $3,000, so it isn’t practical to offer many funds in an HSA platform, said Peter Delano, a senior analyst for TowerGroup in Needham, Mass. There aren’t enough assets in the accounts to parcel them out over several funds, he noted.
Following Jan. 1, when changes to HSA laws that made the accounts more attractive to the rich went into effect, account providers and mutual fund companies began teaming up to make the investment offerings more appealing to the higher end of the market, Mr. Remjeske said.
The law changes permit rollovers from IRAs into HSAs, account contributions greater than the health insurance plan’s deductible, and contributions up to the full annual limit regardless of the month the HSA is started (InvestmentNews, Jan. 8).
The maximum annual HSA contribution this year is $5,650 for a family and $2,850 for an individual.
HSA assets will increase to at least $10 billion and possibly to as high as $20 billion, from $5 billion, by the end of the year, according to Mr. Remjeske.
Formerly, the low account balances were of little interest to mutual fund companies, he said.
“Large IRA balances’ being moved into HSAs would drive account providers to offer more investment options,” Mr. Delano said.
Advisers need convincing
But a “catch,” according to Mr. Ellis, is that HSA tax deferral wouldn’t be a factor in rolling over the contributions, which already received tax deferral when they were placed in the IRA.
HSA providers may have to convince not only the wealthy about account benefits but the advisers of the wealthy, as well.
“The number of HSA accounts that are big enough to catch the attention of investment advisers — accounts with balances over $25,000 — is so small, it’s less than 1% of the existing accounts. I think advisers are acting prudently to ignore this market,” said Tony Novak, principal of Freedom Benefits Association, an advisory firm in Narberth, Pa.
“Investment choices in HSAs haven’t been super, but most of my clients use the accounts to pay medical expenses, and not for savings,” said Jon Beyrer, a financial adviser with Blankinship & Foster LLC in Solana Beach, Calif.
Another obstacle to HSA growth in the high-net-worth market is the high-deductible health insurance plans required in conjunction with the accounts, Mr. Novak added. Wealthier clients prefer a full-coverage health plan and don’t need the cost savings that the high-deductible plan provides, he noted.
They also aren’t excited about HSAs, because of the low maximum annual contributions, and the tax savings is “a minor footnote” for them, Mr. Novak said.
“There’s also concern that if the investment choices become too aggressive, the government may rethink the tax advantages of these accounts,” Mr. Ellis said.
“Funds in HSAs were intended by the government to be spent — not used by the wealthy for savings,” he added.
“There’s now no lack of HSA investment options, but there is a lack of adviser awareness of those options,” Ms. DeWitt said. “That’s because there hasn’t been a lot of marketing done by the account providers.”