W. Scott Simon
Depending on the source of information, there are 300 to 400 HSA providers in America; some even say there are as many as 2,000 if you count banks that offer their own demand deposit accounts (checking accounts) that pay a small rate of interest to HSA holders. In this market, many banks derive transaction-based revenue, which comes from debit card transaction fees, the spread earned on cash in the accounts of HSA holders, as well as any float income earned on cash held.
This business model–which does advisors little good revenue-wise–is the same that banks use in the Flexible Spending Account milieu. The “S” in that market stands for “spending” with FSA holders having to “spend it or lose it” by the end of each year. That can mean lots of transactions and, consequently, lots of fees–for banks. This transactional rat-a-tat-tat business revenue is largely devoid of a fiduciary mindset.
In the HSA environment, though, the “S” stands for “savings,” where the goal for advisors is to change the hearts and minds of employees (and employers) from being spenders into becoming savers and then, (long-term) investors. This model does require a fiduciary mindset.
Very few HSA providers at present–about 20–offer robust investment menus. Whatever the investment menu, though, they should feature institutional share classes and low annual expense ratios (and no commissions or 12(b)-1 fees). This makes particular sense since HSAs are now specifically mentioned in the DOL’s Conflict of Interest Rule, and advisors who provide fiduciary investment advice for a fee are brought within the ambit of the rule.
Very few HSA providers are advisor-centric in the sense of allowing advisors to create their own investment menu for use by HSA holders, design customized investment allocations, and help select prudent investment options within an asset allocation suitable to their own circumstances. HSA providers that permit advisors to offer some combination of these services on one platform with comprehensive advisor reporting are health savings administrators (particularly adamant about the need for first dollar investing) and HealthEquity.
These two HSA providers were among the 10 largest in the country examined by Morningstar in a comprehensive report, 2017 Health Savings Account Landscape, released last summer. Their HSAs were evaluated as spending accounts for current medical expenses and as investment accounts for future medical expenses.
Four HSA providers earned a positive mark for their investment offering: Bank of America, HealthEquity, Optum Bank, and The HSA Authority. Three of these top four are banks. This shouldn’t be surprising, since 99% of HSA providers are banks or credit unions. Nonetheless, the business model followed by banks excludes the option of first dollar investing.
Only one HSA provider, HealthEquity, got positive marks in all four categories evaluated by Morningstar: well-designed investment menu, strong fund manager line-up, good performance, and attractive fees. Good performers included Bank of America, BenefitWallet, HealthEquity, HealthSavings Administrators, Optum, and The HSA Authority.
Working With the Right HSA Provider
Advisors need to partner with the right HSA provider. To me, that means those that can provide the following.
- The flexibility of an open architecture investment platform enabling customization of investment option menus (these menus should include a broad array of low cost, and broadly and deeply diversified investment options of index funds and asset class funds);
- A proprietary, web-based, high quality 401(k) record-keeping system comprising the total underlying platform;
- Active assistance with the on-boarding of HSA holders and the servicing of them, thereby helping make HSA administration easy and profitable;
- Personnel that think and act like advisors, and who have a 401(k) investment and operational background; and
- First dollar investing (that is, HSA holders do not need to deposit some minimum of amount of cash–say, $2,000–before they can begin investing but instead can begin to invest from dollar one).
Conflicts of Interest?
Can advisors looking to enter the HSA market and grow assets under management get paid for doing so only if they get clients invested in mutual funds and ETFs, but not expect to get paid on bank accounts/cash accounts/cash equivalent accounts? If so, this implies that an advisor gets paid only on invested balances instead of total HSA assets (including cash). And that may be a conflict of interest, even though many may think it wrong to charge a fee on assets that include cash.
There is an argument to be made that depending on an employee’s deductible, discretionary income, and other factors, it might actually be prudent for an advisor to advise the employee to keep a higher cash balance on hand than they would otherwise normally recommend.
Is this type of asset allocation advice on cash not advice that an advisor should be paid for? Compensating advisors only on invested assets also incentivizes advisors to have employees invest all their assets, which may not necessarily be prudent depending on the combined market risk and deductible risk in relation to their discretionary income.
Updates
Last month I failed to give credit to Devenir as the source of the statistics cited.
A reader of my January column wrote:
“Great post, and really interesting analysis on how valuable the FICA savings proves over long time periods. One item I disagree with is the example you use of the worker who doesn’t realize he was HSA eligible until tax filing. You can’t take a tax-free reimbursement for a medical expense incurred before your HSA is established.”
The reader is quite right, and I didn’t mean to imply otherwise.
Another reader wrote:
“I read your recent article about the HSA vs. the 401(k) and really liked the article–I am a firm believer in the HSA…[But aren’t] the tax implications for non-spouse beneficiaries of an HSA worse than inheriting a 401(k)? Your article seemed to say otherwise.”
This reader is also quite right, and I didn’t mean to imply otherwise. If an HSA holder dies, a spouse designated beneficiary assumes ownership of the HSA and can use it for qualified medical expenses just as if it was their own HSA. But if the designated beneficiary is not a spouse, the HSA is not treated as an HSA. In that event, the assets become part of the HSA holder’s estate or they go to any non-spouse designated beneficiaries. In either case, they are subject to any applicable taxes.
W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. Simon received the 2012 Tamar Frankel Fiduciary of the Year Award for his “contributions to advancing the vital role of the fiduciary standard to investors, capital markets and to society.” The author’s views expressed in this article do not necessarily reflect the views of Morningstar.