Many Health Savings Account (HSA) plans promote themselves as an account that can be used for investments, often comparing them to a 401k or an IRA. However, is investing your HSA funds a good idea? Like so many investment questions: maybe but, then again, maybe not. Let's look at when it makes sense (and when it doesn't).
First, the basics: health savings accounts (HSAs) are tax-advantaged investment accounts for individuals with qualifying high-deductible health plans (HDHP). If your health insurance plan meets the requirements to be considered an HDHP, you can 1) make tax-deductible contributions to an HSA, 2) allow your money to grow tax free, and 3) take tax-free withdrawals to cover HSA eligible medical costs. That makes the HSA triple tax-advantaged! However, there are rules for how much you can save in your HSA each year.
For 2021, a single individual can make a tax deductible contribution up to $3,600. For family coverage the maximum goes up to $7,200. These two maximums include employer contributions (if any). This amount can be adjusted annually for inflation. For those over 50 years old, the single maximum amount increases to $4,600 and the family limit to $8,200. So, several thousand dollars can be put away every year, tax free, into an HSA account. No wonder the investment of these funds look appealing.
Now, should you be investing that money or leaving it in cash/money market or bond accounts? One important criteria for any long-term investment (which is what all stock investments are) is, can you keep these funds invested for at least seven years (or longer)? For an HSA it is no different, one should invest their HSA only if they can keep these funds invested, regardless of their health expenses for such a period of time. Unfortunately, predicting your health is, frankly, unpredictable. Even the healthiest people can have a devastating accident requiring expensive medical care (in the form of co-pays, deductibles and other uncovered care). Therein lies the key factor as to whether or not investing your HSA funds in higher risk investments (like equities) makes sense. After all, needing to cover large mutli-year medical costs after your HSA investment just lost 35% of its value is a serious risk that most people should never take. History tells us that such investment losses can take 7 to 8 years (or more) to fully recover. If you need to spend that money before the markets recover than you have no chance of getting that lost money back. Out of pocket maximums of, say, $3,000 per year can help but that still means $21,000 to $24,000 needs to be kept in low risk (and consequently low yield) reserves. One should never play "Russian Roulette" with their healthcare dollars.
So, if one wants to invest their HSA funds then they must be able to leave these funds invested through a prolonged health emergency. That means they must have the means to pay for their out of pocket healthcare expenses without using the HSA funds - having gone several years without a health emergency does not count. However, if you do have the ability to fund your health care expenses outside of your HSA then the rewards can be significant.
Keeping funds invested in an HSA for 10 to 40 years (until age 65) can be extremely rewarding from an investment perspective. All earnings in the HSA are tax deferred until they are withdrawn. However, unlike a 401k and IRA, there are no required minimum distributions from an HSA. Another difference between an HSA and a 401k (or IRA) is that the HSA has a hefty 20% penalty if you use withdrawals for other than approved medical costs. However, at age 65 the 20% penalty is removed and withdrawals are then taxed only at your ordinary income tax rate (just like a 401k). However, the ability to pay no tax on withdrawals used for eligible medical expenses remains throughout the life of the HSA.
While one cannot contribute to an HSA after they are on Medicare, the accumulated funds in your HSA can be used tax free to pay many Medicare related costs; like Medicare premiums, co-pays and deductibles, as well as for healthcare services not covered by Medicare. However, one cannot use HSA funds tax free for Medigap premiums.
Finally, after you have forgone reimbursement of your medical expense for many years you may have a large amount of unreimbursed eligible medical receipts. You never lose the ability to withdraw eligible medical expenses from your HSA tax free - even if those eligible receipts remained unclaimed for 50 years!
While for many people investing their HSA funds is not recommended, for the few with the ability to pay their medical costs from earnings without the use of the HSA funds, the financial reward can be very significant. If you have more questions about this approach to increasing your tax deferred savings and investments don't hesitate to contact us.
About the Author: Milt Fullen is a CPA and CFP® fee-only fiduciary advisor with more than 30 years of experience in the financial services industry. He is a multi-year winner of Columbus Monthly’s Five Star Wealth Manager Award, and Fullen Financial Group ranks among Columbus Business First’s top fee-only financial planning firms in Central Ohio. We have helped over 200 individuals and families prepare for retirement, and we manage more than $180 million of assets on behalf of our clients. Our team of professional advisors has a wealth of experience and the best credentials in the industry, supported by the latest technology tools and a dedicated client service team.
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