Medical costs are rising. Stocks are slumping. How to get the most bang out of your HSA
Rising medical costs and recent volatility in stock and bond markets could prompt Americans to consider investing in health savings accounts, especially as open enrollment season begins. HSAs, where individuals with highly deductible insurance plans save for qualifying medical expenses, have one thing no other investment has: a triple tax benefit. Contributions are tax deductible; Investment growth, interest and dividends are tax free and there are no levies on withdrawals for qualifying medical expenses. However, to get the most out of those tax savings, you need to put some of the money into longer-term investments so it can grow tax-free and, ideally, be used in retirement. The money in your account is updated year over year, unlike flexible spending accounts. You can still get reimbursed years later for qualifying expenses incurred now, as long as you keep the receipts. “This is another bucket for retirement,” said certified financial planner Candace Lee, vice president at Glassman Wealth Services in Vienna, Virginia. However, she suggests maximizing your retirement accounts like 401(k) first before maximizing your HSA. You can contribute up to $3,650 for individual insurance and up to $7,300 for family insurance in a 2022 HSA. In the next year, that maximum increases to $3,850 for an individual health plan and $7,750 for a family plan. It’s helpful to save some money for future medical expenses, as these are likely to be higher as you get older. A 65-year-old couple retiring this year can expect to pay an average of $135,000 in medical and healthcare expenses in retirement, not including long-term care, according to an estimate by Fidelity Investments. That’s 5% more than last year’s estimate. But seniors are not the only ones affected by high medical bills. Overall healthcare spending has also increased, accounting for 20% of total U.S. gross domestic product in 2020, compared to just 5% in 1960. For this reason, it’s important to also have money on hand in an HSA to pay for any expenses you may incur cannot cover with your income. A good rule of thumb is to set aside the amount of your deductible in cash or as fixed income, said CFP Carolyn McClanahan, founder and director of financial planning at Life Planning Partners in Jacksonville, Fla. The average overall annual deductible for an HSA-qualified high-deductible health plan in 2021 was $2,454 for individual insurance, according to the Kaiser Family Foundation. “You have to make sure you can record that [deductible] should a catastrophic event happen to you,” she said. Most Americans avoid investing in stocks or bonds in their HSAs, which means they potentially lose tax-deferred long-term investment growth. Only 9% of HSA accounts had investment choices between providers, according to the 2022 Morningstars Health Savings Account Landscape Report. According to the report, however, investment account assets made up over 36% of total assets Also contribute to your savings.Insured workers living in Those enrolled in HSA-qualified high-deductible health plans receive an average annual employer contribution to their HSA of $575 for individual insurance and $987 for family insurance, according to the Kaiser Family Foundation. They can also open an individual account through a provider. Morningstar ranks #10 the top HSA provider with two uses: as a spending account to cover ongoing costs and as an investment account to save for the future. Fidelity has prevailed for both. Fidelity’s 1.19% interest rate on its spending accounts is the highest it offers. There are also no maintenance or other additional fees. When it comes to investment accounts, providers should offer compact yet diverse investment offerings with high-quality strategies at the lowest possible prices, whether active or passive, wrote Tom Nations, associate director of multi-asset and alternative at Morningstar Strategies. In determining its ranking, Morningstar evaluated the HSAs’ menu design, the quality of the investments, the total cost to the investor, and the investment threshold — the amount of money that must be held in the account before dollars are invested in investments. Five of the 10 providers offer brokerage windows tied to the account, allowing users to invest in anything available on the brokerage platform, Nations noted. These are Fidelity, First American Bank, HSA Bank, Lively and Optum. All 10 offer investment menus. If your employer offers an HSA, you can compare costs and investment opportunities with each plan. You can choose to stay with your employer’s plan for your contributions or open a separate account. The easiest way to do this from a tax perspective is to fund your employer account through payroll deductions, if you can, and then transfer it to your individual account, Nations told CNBC. “You can transfer the balance fairly regularly without any tax consequences,” he said. However, depending on the provider, transfer fees may apply. Deciding How to Invest How you use your HSA will determine your overall investment strategy. Morningstar outlined three different approaches in its report. The first, the bucket approach, involves dividing assets into three need-based buckets that can separate HSA spending money from longer-term fixed assets. Short-term money flows into very conservative cash, money markets and short-term bonds. Money that is not needed for another seven to ten years is invested in high-quality bonds. Anything you stash away for more than a decade can go into stocks. Balanced and target-risk strategies like the Vanguard LifeStrategy range offer a one-stop alternative if you don’t want to manage multiple funds, Nations says. These are good for medium to long-term money, meaning you may need to reallocate money for immediate needs. However, the managers of the strategies will rebalance. Finally, if you can afford to pay your expenses without diving into your HSA, you can invest for the long term. However, Nations does not suggest treating it like your 401(k) or IRA. While you can use your retirement plan as a template for your HSA, consider reducing stock risk if you end up needing the money. “Don’t be a forced seller. Avoid tapping into HSA balances during market downturns as it depletes reserves and capital, which could multiply as markets recover and over the longer term,” Nations wrote. On the other hand, if you absolutely know you don’t have to tap into your HSA until retirement, Carolyn McClanahan suggests getting more aggressive about your retirement plans. “Too many people make their investments in mirror images. It’s not tax wise,” she said. Both the Roth IRA and HSA can grow “tax-free forever,” so they should be the last thing you touch. When it comes to what to invest in, McClanahan said, keep it simple and align it with your overall investment policy. “Don’t get too imaginative with your HSAs. Use low-cost index funds,” she said. Also, remember that once you turn 65, you can withdraw money for nonqualified medical expenses and be taxed just like your 401(k) or IRA. “There is no penalty for saving too much,” Nations said.