Investing in an HSA Revisited

Another followup to my article about HSA contribution limits for 2013… A reader named PC had the following to say about my plan to invest within our HSA:

I am not especially well informed about the HSAs but I understand the purpose of the HSAs is that they have a tax benefit in order to encourage savings for future healthcare costs.

Healthcare costs are usually large and unexpected in nature. Wouldn’t you want those ‘savings’ to be readily available (i.e., liquid)?

It seems slightly odd to encourage stock market investments to be made using ‘healthcare emergency funds’.

That said, your strategy is fine assuming you have cash set aside, sufficient for those high deductibles.

PC hit the nail on the head at the tail end of his (her?) comment. I would never invest money that I might need in the short term. But money is fungible. That is, one dollar can be readily substituted for another dollar.

I look at it this way: I can either drain the HSA to cover our medical expenses and then invest in a taxable account, or… I can use those taxable dollars to pay for our medical care and keep the cash in our HSA for investing.

Yes, it’s possible to invest money in an HSA. In fact, with the right custodian, you can access a broad selection of low-cost mutual funds.

As a quick reminder, HSA contributions are tax deductible on the front end. You can then withdraw the funds tax free (with proper documentation) to reimburse eligible medical expenses. The beauty of this is that there is no requirement that you make the withdrawal immediately.

Because you can wait as long as you want to take the distributions (even after you’re no longer eligible to contribute to your HSA), you are free to invest the money and let it build. Importantly, you can also claim expenses that incurred after you lose HSA eligibility.

And finally… Once you reach age 65, you can take non-qualified distributions by paying taxes (just like a traditional IRA) and no penalties.

To sum up, contributions are deductible like a traditional IRA and eligible (medical-related) distributions are tax free like a Roth. Thus, assuming that you have enough medical costs to support all withdrawals, this is like a supercharged Roth IRA (tax deductible going in, tax free [including earnings] coming out).

And the worst case scenario is that this defaults back to being (essentially) a traditional IRA at age 65, when you can take taxable distributions whether or not you have medical expenses to back it up.

The only sticking point right now is that our HSA custodian is awful. The good news is that my employer is changing custodians in the near future. On top of that, I’m actually free to move the money to a custodian of my choice — though I’ve been letting the money accumulate (and earn interest) until the balance gets a bit bigger.

11 Responses to “Investing in an HSA Revisited”

  1. Anonymous

    Art, look into TIPS, this will allow you to not pay taxes on capital gains you get from investing since they’re state tax free. Normally you pay fed tax but since hsa is not taxed federally, no tax there either. You will only have to pay state taxes on contributions.

  2. Anonymous

    I’ve learned that investment income from HSA accounts are taxable in California. Sadly, the California law is not harmonized with federal law. So, for us, it’s not quite like an IRA. I try to keep my investments in my HSA pretty simple — very limited trading. The asset allocation here though is more conservative than my overall portfolio … I use this account more like an emergency fund, but with some growth in mind.

  3. Anonymous

    My employer has our HSA accounts set up with a local bank which charges no fees but also no investment choices, just a savings account.

    I set up an account with Health Savings Administrators and whenever my balance in my local bank gets above $1,000 I transfer it to Health Savings Administrators. It is a little extra paperwork having an HSA in 2 accounts but it has worked good for me by letting me invest in low fee Vanguard mutal funds with my HSA.

  4. Anonymous

    Alliant Credit Union has a great, no-fee HSA. They’re currently paying 1.5% APY (down from 2.0% for all of 2011). My employer does not work with an HSA custodian, which is a bummer because that leaves me no option for avoiding FICA. Even so, I love my HDHP+HSA.

  5. Anonymous

    I am no longer contributing to an HSA because my husband’s employer pays 100% of our health care. But I had one in the past. The money continues to grow and I treat it as a retirement account. Initially the funds were with a bank, but after research, I moved it to Health Savings Administrators. I applied online and receive quarterly statements. They had much better investment options and a payment card to use for medical expenses. The yearly maintenance fee is nominal, much lower than the bank’s fees. I thought it was an awesome way to save for health care. It makes people be proactive about their health and consciously decide when they truly need to see a doctor. That said, it is imperative money for the high deductible is readily available for unforeseen emergencies. But once that fund is built up, the excess funds can grow quite nicely. My account has almost doubled. I also never used the funds. I covered my nominal visits out of monthly expenses. I wish I could continue to fund my HSA. By the way, I have no affiliation with Health Savings Administrators. I found them after research on the Internet.

  6. Nickel

    BG: Yeah, it’s mainly the seed money/matching funds, but that has decreased each year so I think it will ultimately go away. Beyond that the only difference is avoiding FICA — and if you’re over the Social Security income limit, then you only save the 1.45% on Medicare which may be a reasonable price to pay for simplicity.

  7. Anonymous

    Nickle) why not change your HSA custodian? I’m pretty sure you can pick whichever custodian (bank) you want — just let your employer know who you are using if you are making automatic contributions every pay period.

    HSAs aren’t tied to insurance companies or employers.

  8. Nickel

    Jim (comment #1): Yes, you can save on FICA, but only if you have the contributions withheld from your paycheck. If you make the contribtions yourself, you get to deduct from income taxes, but you pay FICA. This is the main reason I’ve opted to use my employer’s custodian (at least for now).

    jim (comment #2): Ours is similar. If we dip below a minimum, there’s a nasty monthly fee. And most of the alternatives that I’ve looked at have similar rules. Thus, if we want to: (1) avoid fees, (2) keep using my employer’s custodian to get the FICA break, and (3) open another account with better investment options so we transfer money over periodically and invest it… Then we’ll have two slugs of “dead” (liquid) money earning a pittance.

    This is why I’m excited that my employer is switching to a new custodian. Hopefully their investment options will be better (can’t be worse) and I can avoid having to open a second HSA for investment purposes.

    The alternatives are to: (a) simply draw the account down and give up on the idea of investing in our HSA, or (b) drop my employer’s HSA, give up on the FICA break (we really only benefit from the Medicare portion since my annual salary exceeds the Social Security earnings limit), and just fund a better HSA on our own.

    The latter would be easier and we wouldn’t lose much. However, my employer has also been providing seed/matching contributions to the HSA so I’ve been compelled to keep an account with their custodian to get that free money.

    In the long run, I suspect they’ll phase out the seed money (it’s mostly an enticement to get people to switch to the HDHP) so perhaps our decision will be simplified in the future. Of course, this is all a non-issue if the new custodian offers reasonable investment choices without a ton of fees.

  9. Anonymous

    My HSA plan has a requirement that I keep at least $2000 in a liquid form. For amounts above the $2000 I can invest that in mutual funds. I don’t know how common that is for HSA plans.

    My HSA plan investment offerings aren’t too good and the mutual funds are all high load and expense.Thus far I’ve kept all our funds in liquid form. I’m not earning any interest but its a nice tax deduction.

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