HSA Investment Strategies

Health Savings Account’s or HSA’s are one of the most valuable savings vehicles most employees have.  Today we’re going to explore some HSA investment strategies along with their pros and cons.

What is an HSA?

Let’s start with the simple, what is an HSA? An HSA is a tax advantaged plan setup by the government for the purposes of medical spending.  The idea is people can put money into an HSA tax free, and so long as they utilize the funds for medical purposes the withdrawals are also tax free.  This is one of the few accounts where you can pay no tax on either input or withdrawal.

What is an FSA?

These are not to be confused with Flexible Spend Arrangement or FSAs.  What are FSA’s?  FSAs are employer run plans where you input money into an account tax free and then can use it tax free for health care expenses.  Sounds pretty similar so far, right?

The Difference between an FSA and HSA

Well now we get into the real differences.  The biggest one right off the bat is an FSA is just a pull of money for health expenses this year.  The money you put in is available to be used in the exact amount you put in for health care in the current year.  Use it or lose it.  An FSA is not an investment plan.   An FSA is just another way to get deductions on health care expenses.  It only works well if you can determine your medical expenses will be beyond a given number for the next year before it begins.

An HSA however is an investment account.  Essentially you contribute money to the account which is held at a brokerage firm.  You can then choose to invest that money as you see fit until you are ready to pull it out and use it.   That could be now, or 30 years from now.  

Who Qualifies for an HSA?

As a matter of income anyone qualifies for an HSA.    In fact you do not need to have an income or even a job to have an HSA.  So long as you are not a dependent on someone else’s return you qualify.   You can setup an HSA individually through a brokerage or via your employer.  This flexibility makes these accounts ideal for the high income individual or family.  Anyone can contribute individually up to $3,450 a year or as a couple $6,900 a year.

Medical Insurance Requirements for an HSA

There are some medical insurance requirements for having an HSA, particularly you must not be on medicare.  Also you must be covered by only one health insurance plan, one that meets requirements for being a high deductible health plan (HDHP).  These plans must be identified by insurers as meeting some requirements.  Typically it means higher annual deductibles (a minimum of $2700 for family coverage or $1,350 for individuals in 2018 for in network) and higher out of pocket maximums (a maximum of $6,650 for single coverage and $13,300 for family in 2018 for in network).  Further qualification information can be found here.

Triple Tax Advantaged Account

Now that we’ve established qualification and the setup of the plan what does this all mean?    Well this all makes the HSA the only account in existence where you can contribute, withdrawal earnings, and withdrawal principal all without paying a tax.  (so long as it is  used for medical purposes. ) Who can’t help but like tax free money.

The thing to remember is first and foremost an HSA is an investment account.  That means you should invest the money.  But how much of it should be invested versus how much should be liquid to pay yearly medical bills?  There in lies the strategy.

HSA Expense Reimbursement Rules

If you remember I mentioned an HSA can be used for medical bills.  However what I did not mention was which years medical bills.  Essentially a qualified medical expense is defined as any medical expense incurred by you or your dependents.  Medical expenses being pharmaceuticals (but not without a prescription),health insurance (when used for cobra, under unemployment, or medicare over 65 but not medigap.  Normal health insurance cannot be paid for with an HSA.) , doctors visits, surgery, or really any type of normal medical expense.  However these expenses are applicable if they occur any time after you signup for an HSA, including after you have stopped contributing to the plan.  In fact you don’t even need to apply them in the year they happen.

HSA Strategy Number One: Invest it All

This brings us to strategy one.  The first way you could manage this account is to contribute and invest all contributions immediately.  Pay all medical bills going forward with cash from your normal accounts.  Save the receipts and then sometime long in the future use the proceeds of the investments to reimburse your self for the receipts.  All the gains and principal would still be yours no matter how long you waited.  

Honestly I’m not a big fan of strategy one.  It sounds like a great way to go until you peel back the onion of risk.  The first concern is lost receipts.  If your home were to burn down, your receipts were to degrade, or even if you lost them you’d be out of luck.  Then you’d have to wait for the money until you incurred those expenses again.  That may or may not be a big deal.  Your spouse can inherit your HSA as it is, but your non spouse heirs would inherit the funds as a taxable account.  Worse still non spouses will have to pay ordinary income tax on the entire value of the account.  So needless to say you don’t want both you and your spouse to die with a large HSA as all that tax savings you’ve been saving up would be for naught.

The final reason I don’t like strategy one is the fear the government will change the law.  If enough people game HSA’s to impossibly large accounts the government may someday change the laws to make higher amounts in these accounts taxable.  You would have traded a sure tax break now for something less so later.  A bird in the hand is worth 2 in the bush.

Strategy 2: Invest Funds Over Annual Out of Pocket Maximum

The second strategy for an HSA is to invest funds over your annual out of pocket maximum.  This is the truly conservative approach where you can pay all of your possible health care bills in a given year with the money and only the remaining funds get invested.  Frankly I’m not a big fan of this approach either, especially for those of us on the younger end of the spectrum.  How likely is it you will hit the out of pocket maximum in any given year?  For most of us not very likely.  Any money not invested is money lost to inflation over time.  You want to maximize the money invested compared to what you plan to spend.

Strategy 3: Invest Funds Above Expected Medical Expenditures

The third strategy is to invest the portion of an HSA above what you expect for a given year.  For lack of explicit levels of spending a reasonable average could also apply.    I tend to prefer this approach.  I take the lower end of my average years medical expenses, and these are invested in either short term bonds that mature in that year with a little left in cash.  Everything else is invested in stocks for future years.  What if I under estimate my needs?  Well then I would carry the receipts, no harm no foul unless a change in the laws were imminent.  But otherwise I can use the HSA for what I need now and invest beyond that point going forward.

Strategy 4: Limit Deposits

I’m loath to mention option four, which is to limit Deposits to only your expected medical expenses for a year.  You’d be giving up all that tax free investment space.  If you remember our post on tax free investing  and free match money I prioritize investing this account first over all other tax advantaged accounts.    So unless I can’t afford to save more then my 401K match and be liquid, I would always have an HSA investment and I would always recommend putting in as much as you can. 

You might be saying, but what if I don’t use the funds?  Well your account would have to be very large or your life very short for the that to be a high likelihood.  I highly doubt most of my audience will have this problem with the contribution limit at just $6900 a year for a family.  For the younger crowd for reference each of the natural births of our children cost about that much.  $6900 is not a lot as you get older.  Remember there is no other account that gives you the triple tax advantage.

Strategy 5: Asset Allocation and HSA Accounts

Finally we have strategy five, which is not necessarily an independent strategy.  If you remember from our accounts discussion long ago  assets should be considered based on their distribution across all accounts.  An HSA is at it’s core just another account.  As a tax advantaged account it should always contain the least tax advantaged investments you own so  as to maximize your benefit. 

Beyond that your HSA should not be invested in percentages equal to your overall asset allocation.  It should be considered a piece of that allocation.  As such you could say, load your HSA up with mostly bonds with a set time frame, to coincide with a predicted future medical expense.    If your overall asset allocation does not change then the net impact to you is positive.  If you had lower expectations for near term expenses and were less worried about law changes you could pile into stocks while buying your bonds in other accounts.  It’s truly a personal decision once you exclude bad ideas like investing it in tax free munis.

Do you have an HSA?  How do you invest it?  Any other strategies I missed?