Editor’s Note: For those who aren’t familiar with Health Savings Accounts, I’ve written extensively on the topic before, take a look.
Reader GP writes in this week asking about HSA’s:
I’ve got a pretty substantial HSA balance now and I need to know how to invest it.
Simple and to the point, I like those types of questions. As you may or may not know, HSA’s are my favorite investment vehicle of all time. I probably won’t stop writing about them until everyone in America has one. The reason why I love HSA’s so much are because they encompass two things close to my heart: they stick it to the insurance industry and they allow you to completely avoid taxes.
HSA’s force you to consider the cost of medical procedures and insurance only comes into play when you truly need it(ie a catastrophic event). There’s no point in insuring things like simple doctor visits and routine check-ups since we know we’re going to need those. Involving a third party in something like that is only going to make it more expensive: that’s ECON 101.
There are lots of reasons to not like paying taxes but an HSA is the only answer I’ve found to truly(and legally) avoiding taxes. The money you put into an HSA is tax free, the money you take out is tax free and your investment gain is tax free. Do I need to say more?
How do you Treat Your HSA?
The first thing I asked reader GP was how he treated his HSA. I treat my HSA as an extension of my 401(k) so my contribution order is 401(k) up to the match, HSA up to the max and then a combination of 401(k)/Roth IRA until I hit the contribution limits. Remember, even if you don’t end up spending the money in your HSA on medical expenses you can still withdraw the money after the age of 65 just like a normal 401(k).
They say that nothing is certain in life but death and taxes. I think you could add one more item to that list though: the cost of health care. I’m about 99% sure that the cost of health care will be going up as we get older. I also think we’re going to need more of it as we get older(duh!) so why not plan for it now? Fidelity estimates that a 65 year old couple retiring in 2013 would need $220,000 to cover their medical expenses for the rest of their life time. That’s more than some people even have saved up for retirement.
The government is giving you a way to pay for your medical expenses completely tax free and it’s a good idea to take advantage of it while it lasts(HSA’s might come to a crashing halt when I withdraw $30,000 of saved receipts in 30 years and pay for my yacht). That’s another cool feature of the HSA: you can pay for your current medical expenses with your after tax dollars instead of your HSA money, save the receipts, and withdraw that money at ANY point in the future.
So let’s say I pay for $1,000 worth of medical expenses in 2014 with regular after tax dollars instead of my HSA money. That leaves $1,000 in my HSA that will grow to $7,612 over 30 years(assuming 7% growth) and in 30 years I can withdraw that original $1,000 tax free(and spend it on whatever I want) and use the other $6,612 to pay for my medical expenses in retirement(again, tax free!).
Invest or Use Your HSA
Reader GP told me that he doesn’t have many medical expenses but when he does he pays for them with his HSA. That’s a fine strategy too since if you don’t go to the doctor much you’ll quickly rack up a decent amount of cash. In this case, I advised GP to keep a small buffer in cash(equal to his deductible) and invest the rest. That way he’ll be able to cover any large medical expenses that may come up but he’ll still be able to start investing his money today.
If he has a decent emergency fund, he could actually invest the entire amount and pay himself back should any large medical expenses come up.
Let’s assume that GP invests his entire 10k HSA balance but has $2k in medical expenses this year. GP can wait until he has contributed $2k into his HSA again(through payroll and employer contributions over the course of this year and next year) and withdraw that money or he could wait until his investments are at a gain and sell part of those and pay himself back that way.
Short or Long Term Use?
If you plan on needing/using your HSA money in the future it’s not a good idea to invest in anything too risky(ie stocks/longer term bonds). But if you are treating your HSA as a long term investment vehicle, you should invest it accordingly. Personally, I invest my HSA in 70% stocks(VB – Vanguard Small Cap ETF) and 30% bonds(TIPS – iShares TIP Bond ETF). You can read more about why I invested that way here.
In reader GP’s case, I advised him to invest in a total market index fund(like VTI) and an inexpensive bond fund or even a target date retirement fund. I take a little less risk with my HSA but any asset allocation that’s age appropriate will work just fine for your HSA. One thing to keep in mind is that if you live in an HSA taxable state like California you will have to pay state taxes on the investment gains(in addition to contributions).
Where to Invest?
The last thing to consider is where you’re going to invest your money. Most employer offered HSA plans have horrible investment options so you probably want to avoid investing there at all cost. I just wrote about my latest HSA provider but there are lots of options to choose from. I like companies that offer low or no fees, no minimum balance requirements and free investing. The only one I’ve found that hits all of those is Eli Lilly Federal Credit Union. They have no fees whatsoever and they allow you to invest in commission free ETF’s through TD-Ameritrade.
You can do partial or full transfers(trustee to trustee) from your employer’s HSA plan to ElfCU as many times as you want in a given year. If your employer’s HSA plan does charge a fee for doing a transfer you can do a self-rollover once a year for free. I usually do a trustee to trustee transfer at the end of every year.
Readers, is the HSA not the greatest investment account of all time? If you have a question for me, please contact me and I’ll do my best to answer it.
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-Harry @ PF Pro
What is your take on California where HSAs are not recognized??
Harry Campbell says
Well obviously I would prefer if they were recognized but you still get the federal(25% for me) and ss/med tax(6.2% + 1.65%) savings, so that’s pretty significant. CA taxes(6-8%) are not much compared to that amount and there are ways to reduce the taxes on your investment earnings like I describe above.
If I was in a recognized state, I’d probably keep it simple and invest in a total market stock fund like VTI(70%) and a total market bond fund like BND(30%).
I would also have to mention that my employer currently does not offer insurance with an HSA so I wouldn’t get the SS/MED savings through payroll… just the Federal tax savings.
Harry Campbell says
Are you considering opting out of your employer’s PPO plan to buy an HSA plan on your own? Not sure if that would make financial sense but send me an e-mail and we can figure it all out if you’d like… [email protected]
Jon @ Money Smart Guides says
I treat my HSA like a retirement account. I don’t take any money out for medical expenses, I just pay out of pocket and let the money grow tax-free to be used at a later date. When it comes to investing the money, you have to do your research. Many of the HSA firms charge fees – all kinds of fees. You have to find one that meets your needs best and doesn’t cost you an arm and a leg.
Harry Campbell says
I think that’s the best way to use it too. Although ElfCU just instituted a $24 wire transfer fee they are still the best option for investing your money IMO: https://yourpfpro.com/new-hsa-provider-eli-lilly-federal-credit-union/