How to approach an HSA: Contributions, Savings & Investments
An overview for new HSA users, a refresher for everyone else
A Health Savings Account, or HSA, may be one of the most versatile and tax-efficient savings accounts available to consumers. Designed to be paired with a qualifying High Deductible Health Plan (“HDHP”), the HSA builds upon the tax advantages of familiar Flexible Spending Accounts (FSA’s), and adds a number of new features that turn this health-oriented savings accounts into something far greater — a supplemental retirement account. When combined with other financial planning strategies, an HSA can become a core component to creating tax-efficient, long-term financial security.
A word on HDHPs. Before getting too far ahead, keep in mind HSAs are critical to the health care industry’s migration to High Deductible Health Plans. Unrecognized by many, HDHPs work similarly to many other health insurance plans with a few notable exceptions imposed by the IRS, with the most important for this post being the addition of what is essentially a “self-insurance” component.
This is achieved through the increase in the out-of-pocket deductible, a threshold established by the IRS that “qualifies” the plan as acceptable for ongoing HSA contributions. This increased minimum feature also comes with a max out-of-pocket level, capping an individual’s financial exposure in a given year. While still a large number, roughly twice the annual maximum HSA contribution level, this provides a useful early target when incorporating HSAs into broad financial planning and initial recommendations. This max out-of-pocket can be thought of as a similar concept to property and casualty insurance, where some risk is maintained up to a certain amount, while the remainder, generally the truly catastrophic, is transferred.
HSA Contributions, Savings and Investments: A tutorial for some, a refresher for others.
While a full discussion of HSAs within the broader context of financial planning is beyond the scope of this post, a few principles are worth keeping in mind while learning to use your HSA and obtaining the most from the account, for both today’s health expenses and even non-health expenses down the road (yes, it works for those too, see below).
Contributions.
Generally speaking, HDHP participants should make monthly contributions to take maximum advantage of any HSA funding match offered by their employer, as well as establish a minimum level of savings equal to the minimum annual deductible. For 2019 this amount is $1,350 for individuals and $2,700 for families. Funds deposited in HSAs enjoy tax free withdrawals when used to pay for qualified health expenses, and not only income tax free but also payroll tax free; these funds really can be the most financially efficient way to pay for healthcare.
While this question can easily surface other aspects to financial planning such as risk appetite, excess monthly cash flow, other account balances and total wealth picture…
Importantly, and unlike FSAs, HSA contributions and year end balances do not expire with each new benefit plan year. Further, they are portable from employer to employer, and can even be rolled over from one HSA provider to another, similar to IRAs. These accounts are “owned” by the taxpayer and therefore that individual has full rights and benefits independent of employment status. Similarly, HSA funds pass to beneficiaries upon the death of the account owner, so similar to other financial accounts the money is never lost. For these reasons and more individuals should not fear “over-saving” with their HSA contributions.
Savings.
One area new users — as well as old users — often want guidance on is how much to place into an HSAs savings account, and consequently how much to invest through the brokerage feature. While this question can easily surface other aspects to financial planning such as risk appetite, excess monthly cash flow, other account balances and total wealth picture, among many, a useful rule of thumb is to keep the minimum annual deductible in the “cash” savings account and consider investing some portion of the remainder. More conservative savers may wish to increase this cash savings amount to the annual max out of pocket limit.
Fortunately, HSA brokerage options often allow the user to access many, if not most, of the same types of now familiar investment features found in their employer sponsored retirement plan and/or IRA accounts.
A variation on this theme may be to further divide the savings funds into general-purpose medical expenses and a second for identified upcoming qualified expenses, like braces, knee replacement or other health care costs that can be scheduled and are identifiable. Knowing the money is available, and more broadly that you have an established plan, can provide a peace of mind beyond the actual account balance.
Investments.
Most of “the action” in HSAs seems to center around the brokerage, or investment feature. This is understandable, as health care costs continue to expand at a rate greater than inflation, while at the same time the costs are being shifted onto the individual through premium increases and larger co-pays and deductibles. This tends to support a “growth” investment orientation in a general portfolio, principles that apply equally well to an HSA brokerage.
Fortunately, HSA brokerage options often allow the user to access many, if not most, of the same types of now familiar investment features found in their employer sponsored retirement plan and/or IRA accounts. Stocks, bonds, money market and other funds can be invested in to achieve similar short and long term wealth and life objectives. Importantly, and as noted above, HSA balances never expire, nor do qualified health expenses lose their “tax-exempt” status for future HSA withdrawals (the underlying concept to a “shoe-boxing” savings strategy).
Practically speaking, then, an HSA can be a very good, perhaps the best way, to save for out-of-pocket health expenses in retirement. While health risk and corresponding financial exposure can be hard to gage decades into the future, a number of large institutions, such as Fidelity, have estimated it to be well over $275,000 for a couple retiring today.
The best, if not also most reliable, way for individuals and families to meet this level of financial responsibility is to consistently save month after month, year after year, and allow compound interest within an equity-oriented portfolio to work it’s Time Value of Money magic. Importantly, once a holder reaches 65, HSA funds can be withdrawn penalty free for any use, though ordinary income tax rates will apply (similar to traditional IRAs and qualified retirement plans like 401(k)s and 403(b)s). In this way the HSA can act like a supplemental 401(k)/IRA, with additional tax savings available through the payroll tax savings deposits.
While there is much more to an HSA, and good financial planning, account holders should know that their HSA is more than the FSA they might have grown up with. An HSA is probably better thought of as the financial equivalent of a Swiss pocket knife — many functions, some used often, others rarely, but often the best single tool to have on the trail.
About Aaron Benway, CFP, EA — Aaron is a Certified Financial Planner (CFP) and IRS Enrolled Agent (EA). He co-founded HSA Coach, a digital tool to educate consumers on HSAs, track health expenses and other documents, and provide individual financial calculators, to help consumers get the most from their HSA and other savings. To help individuals directly with their financial planning and wealth management requirements he founded AB Financial Planning.
Prior to HSA Coach Aaron was the CFO of HelloWallet, a financial wellness software startup purchased by investment research firm Morningstar. Earlier in his career Aaron was an investor at The Carlyle Group and a nuclear engineer in the US Navy. Aaron has an Electrical Engineering degree from the US Naval Academy and an MBA from Harvard Business School. Aaron lives in the Washington DC area with his wife and two children.
