Investing in an HSA – and why it’s different than a 401K

One of the most powerful features of the HSA is the ability to invest your money to save for future health care expenses.  Fidelity published another sober reminder this week that the average couple retiring at age 65 is likely to incur $245,000 of out of pocket costs in retirement.  Wow!  Really?  Most people are starting to realize that they have a big problem brewing and are not sure what to do about it other than beef up their 401-k saving to try to combat it.  

Good news!  There is a better way to save for health care costs hidden inside your HSA account.

Most people naturally think of their HSAs as a better FSA for this year’s expenses, avoiding the need to predict next year’s health expenses now and lose the money if you guess too high.  The latest Devenir HSA study shows that the average HSA accountholder deposits only about $1,600 in their HSA, when those in individual HSA-qualified plans could contribute up to $3,350 and those in family plans up to $6,650 in 2015.  (By the way, it is not too late to max out your contribution for this year – you actually have until April 15th, 2016 to do so.)  The median account appears to have only $500, which means folks seem to be putting in a little and taking it right out as health expenses are incurred.   That is all fine and good, but totally misses the true value of the HSA.

It is time to start thinking beyond this year and start squirreling away money in the best investment vehicle available today: your Health Savings Account!  Yes, most people don’t realize it, but their HSA often includes options to invest money in mutual funds or even a full discount brokerage or self-directed HSA options.  Less than 3% of HSAs include investments, according to the Devenir study, but in my recent White Paper entitled: The Coming HSA Investment Wave, I predict that is about to change dramatically:

“In our estimate, 7.5 million of today’s 13.7 million HSA accounts are less than two years old.  The average balance of these accounts is only $817.  The vast majority of these do not meet minimum requirements to invest in their HSAs.  Early experience shows us that the vintage of the account is highly related with balance growth and investment activity.  After two years, only 1.4 percent of accounts are investing.  After five years that number will predictably grow to 5.6% and by the eighth year the number of investors reaches 10.5%.    

Therefore, this huge number of new accounts is just becoming aware and qualified to invest and is likely to adopt investments in unprecedented numbers.   All this will accelerate as HSA Trustees improve their investment education or if investment firms enter the space in force.  If this projection plays out as projected, investments will constitute more than one-third of $110 billion in more than 50 million HSAs by 2020.”

So how does investing in an HSA work?

It is pretty simple in most cases.  If you are familiar with investing in a 401-k, you’ve got it licked.  First, check and see if your HSA Trustee offers investments.  If not, consider transferring all or a portion of your HSA dollars to a trustee that will offer you good options (I recommend for researching HSA choices in the marketplace.)  

Once your money is in the right HSA account, you will probably need to deposit enough money to meet a minimum threshold of $1000 or $2000 in order to invest.  The remaining amount in the checking portion of the HSA is used to cover any current spending available to the debit card.

It is not too late to bump up your payroll deduction amount for 2015 – or at least start with a healthier auto-contribution going into the 2016.  Alternatively, you can send a check or have money transferred from your checking account directly to your HSA Trustee, which you can later deduct on the front page of your tax return when you do your taxes next spring.  

Most HSA investment offerings offer a list of no-load or load-waived mutual funds across a broad investment spectrum.  It usually works just like your 401(k) – you first select which funds in which you want to invest, and then every time you move money to the investment portion of your HSA, it will be spread between your chosen funds.  The best programs allow an automated program to sweep all funds over the threshold amount, so that you can purchase small amounts with every paycheck – often called dollar cost averaging in the investment world.

Building peace of mind to handle future health costs.

Once you start this program, you are now building balances that can be used anytime in the rest of your life to pay qualified medical expenses for yourself, your spouse, and any tax dependents at the time of the expense.  You can even pay current bills out of pocket and create future tax-free withdrawals while letting your HSA account grow tax-free in the meantime.

Why not just use your 401-k for the same purpose?  Because the HSA gives you a tax-free advantage for any money used for medical expenses.  To cover the expected hypothetical Fidelity estimate of $245,000 of medical expenses in retirement you need to save almost $327,000 in a 401(k) or IRA if you will be in a 25% tax bracket in your retirement years.  In an HSA you need to save only $245,000, because the money all comes out tax-free from the HSA.  In addition, in the unlikely event that you have too much in your HSA and not enough medical expenses in retirement, you can withdraw HSA funds penalty-free after age 65 for any purpose – the same tax treatment you will get for 401(k) or traditional IRA withdrawals and without required minimum distributions or means-testing.  

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Todd Berkley is an HSA industry veteran who runs, and is the author of the HSA Owner’s Manual.


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