How to approach an HSA: Contributions, Savings & Investments

A Health Savings Account, or HSA, may be one of the most versatile and tax-efficient savings accounts available.  Designed to be paired with a qualifying High Deductible Health Plans (“HDHPs”), the HSA takes the tax advantages of familiar Flexible Savings 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.

Basic Overview, for Newer HSA Users

A word on HDHPs.  Before getting too far ahead, keep in mind HSAs are a necessary component to the healthcare industry’s migration to High Deductible Health Plans.  HDHPs work similarly to many other health insurance plans with a few notable exceptions, 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 HSA entry.

This increased minimum feature also comes with a max out-of-pocket level, essentially 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 target when incorporating HSAs into broad financial planning.  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 beginner tutorial

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.

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 2018 this amount is $1,350 for individuals and $2,700 for families.  HSAs are tax-free dollars when used to pay for qualified health expenses, not only income tax-free but also payroll tax-free, so these funds really can be the most financially efficient way to pay for healthcare.

Also know that unlike FSAs, HSA contributions do not expire each year and are portable from employer to employer.  These accounts are “owned” by the taxpayer and therefore that individual has full rights and benefits independent of employment status.  Similarly, HSA funds can roll to your heirs when you pass, 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.

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.  Don’t underestimate the value.

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 in addition more of the costs are being shifted onto the individual through not only a noticeable increase in premiums, but also less noticeable co-pays and deductibles.  A similar dynamic is waiting for employees once they retire and participate in Medicare.

HSA investments allow the user to access many, if not most, of the same types of investment features as 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, an HSA never expires, nor do qualified health expenses lose their “tax-exempt” status regarding HSA withdrawals.

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 only 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, 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)

While there is much more to an HSA, account holders should know that the HSA is more than the FSA they might have grown up with.  An HSA is a product best thought of as a financial risk mitigation account specifically geared towards health risk, but more flexible.

Here’s to HSA saving and investing!