Health Savings Accounts—Triple Tax-Advantaged Investing

Victor Colella: Hello. This is Victor Colella, and I’m a financial planner here at Adviser Investments. We’re here with another Adviser You Can Talk To podcast. Today I’m joined by two colleagues of mine who I work with on a regular basis, both CERTIFIED FINANCIAL PLANNERs™. Kari Wolfson is an account executive here at Adviser Investments and Andrew Busa is a financial planner in our central planning group.

Victor Colella: Today we’re going to tell you everything you need to know about health savings accounts, or HSAs, within 10 minutes or less. Health savings accounts were created back in 2003 by our government as a way to react to rising health care costs, specifically for retirees.

Andrew, you’re going to give us the basics, but before you do I just want to give you an idea of how big this problem is. Fidelity recently did a study that says a retiree today can expect to pay almost $300,000 across their retirement for health care costs. That’s a big number. So, Andrew, why don’t you jump in and give us some of the basics?

Andrew Busa: Right. So HSAs are savings accounts that are very tax-advantaged, specifically designed to be used for those health care expenses that you just mentioned. So what really makes an HSA special is that it’s triple tax-advantaged, so we want to emphasize that point.

That means that contributions are tax deductible, growth inside the account is invested as well as tax-free, and distributions on the other end are tax-free if they’re used for those qualified medical expenses. So that means taken all together this is the only tax-free investment that you can make today.

Victor Colella: So basically it’s like a Roth IRA and a traditional IRA had a baby, so to speak? But there’s a restriction. It’s only that tax-advantaged if you use it for health care costs?

Andrew Busa: Exactly. So you can contribute $3,450 per year if you’re an individual and $6,000 per year for a family plan. And to be used for those qualified medical expenses that I mentioned earlier … So this could include things like dental, vision, long-term care premiums, Medicare premiums, COBRA premiums. You know, the list goes on, so they’re versatile.

Andrew Busa: Typically these plans are employer-provided, but they don’t need to be. An important distinction here is that these are not flex spending accounts, or FSAs. FSAs have this use-it-or-lose-it component, meaning that they expire at the end of the year, whatever balance is in them.

HSAs don’t have that limitation, so whatever you contribute to the account rolls over from year-to-year, it rolls over from job-to-job, overall much better than FSAs.

Victor Colella: Okay. So, Kari, you work with clients on a regular basis. What’s the typical client profile that you view as being a good fit for an HSA? So who do you have this conversation with?

Kari Wolfson: Right. So if I think a client is a good fit, the first thing I’m going to do is understand their health care plan a little bit more, so they have to have a high-deductible health plan, and to qualify for a high-deductible health plan their minimum deduction is 1,350 for individuals or $2,700 for families. You can’t contribute once you’re under another type of insurance plan, so no other coverage is allowed, or if you’re currently under Medicare you can’t make contributions, but you can still use the HSA for those expenses.

Income doesn’t really matter, so there’s no phase out, whether it’s a lack or excess of income, and you need enough cash on hand to pay for your current medical prices, because remember, there’s the higher deductible. Another thing we look at is whether they’re a tax-sensitive client, because there’s benefits of contributing to an HSA for tax purposes, and they need to be the right type of health care user.

Victor Colella: So just to back up for a second, you said this high-deductible health plan. Basically the idea behind that rule is the government isn’t going to give you this sweet tax benefit if you’re already covering 100% of your health care expenses through this generous plan for your spouse?

Kari Wolfson: Exactly. So there has to be some out-of-pocket expenses.

Andrew Busa: And you mentioned if they’re the right kind of health care user, so you’re thinking about two major types here. First, if you’re someone who’s healthy, pretty laid back about going to the doctor, you don’t go to the doctor that frequently, this would probably be a good fit for you because you don’t have to worry about hitting that high deductible for your health care to kick in.

On the other hand, if you’re someone who’s unhealthy, you go to the doctor frequently, this probably wouldn’t be a good fit for you if you don’t have the cash on hand to meet all those out-of-pocket expenses, co-pays, et cetera, to hit your deductible.

Victor Colella: Okay. I’m going to zoom back out. One of the reasons that HSAs were created in the first place, like I mentioned before, was to address the huge cost of health care, specifically in retirement. In order for that benefit to exist though, the account has to be around in retirement.

The reason I say this is there was a recent Towers Watson study done that showed that a majority of HSA contributions over the last year actually left the accounts in the same year that they went into the accounts. Basically they’re using it like a flex spending account, they’re spending it in the year that they put it in.

Now you do get a tax benefit. I’ll give you an example. So if you spend the balance of your HSA the year that you put it in you’re basically getting a discount on your health care services equal to your marginal tax bracket, let’s say it’s 30%. But if you let that account double or triple in the market and you continue to contribute to it as you’re working so that it’ll be there in retirement, that tax benefit is more like 50%, growing as the account grows, the reason being is that growth is never taxed. So we encourage our clients to actually use it like a savings vehicle, not a flex spending account which you spend in the same year that you put the money in.

Kari Wolfson: Right. So I had a client recently who just switched jobs and they were evaluating their new health care options. Their previous job, they had an FSA, a flex spending account, but they were always scared of over-contributing, because as Andrew mentioned earlier, you have to use it or lose it each year.

They were also healthy and not heavy health care users, so they weren’t going to the doctor too frequently. They were very high earners, so they could afford to pay for their current health care costs from their savings, from their cash accounts, so they could pay for the higher out-of-pocket expenses. Also, being the very high earners, they were more … You know, they had tax-sensitive benefits that they could take advantage of with the HSA.

So our recommendation was to establish the health savings account, maximize the contributions, and it could be invested for retirement for the long-term-care expenses. The outcome has been going well so far. We think they’re going to have a great resource in retirement and the money is going to continue to grow and be a great benefit for them.

Victor Colella: So let’s say that I’m someone who’s not yet retired, I’m actively saving towards retirement, and I’m trying to prioritize between my 401(k) account, my health savings account, let’s say a Roth. How do you both think about the hierarchy of these accounts, where to direct your savings?

Andrew Busa: I’ll take a first shot at this one. So just as a precursor, there really isn’t one size fits all, but I can say a couple things with confidence. One, if you have a 401(k) employer match available to you, take advantage of it, and if you can take advantage of it in full before you do anything else. That’s free money, and if you have the ability to hit the match it’s a no-brainer. After you’ve taken advantage of that match though, that’s when I think the health savings account, the HSA, comes into the conversation, as well as the Roth account if you’re eligible for contributions, and there are a variety of factors that help prioritize between those two.

But first take advantage of the match, then take advantage of other tax benefit vehicles like your HSA and your Roth. Then if you still have excess disposable income, then you can use it for maybe additional 401(k) contributions, maybe savings outside of your 401(k), your retirement plan, in a brokerage account. Where you go from there very much depends on your situation.

Kari Wolfson: Remember, after 65 your health savings account turns into an IRA anyway, so you can take distributions for non-health care expenses and it’s just taxed as ordinary income. Before the age of 65 though you have a big 20% penalty on any non-health care expenses that you’re taking as distributions.

Andrew Busa: And I really think that’s a point of emphasis. You’ve built up this HSA over many, many years. You hit age 65, all of a sudden that 20% penalty, which is very steep, is wiped away even if it’s not used for qualified medical expenses. It’s ordinary income at that point, but there’s no penalty.

Kari Wolfson: Right.

Victor Colella: Okay. Well, that’s all we have for today. I’m going to give you a quick summary. If you think that an HSA, or a health savings account, is a good fit for you, so you fit the profile that Kari talked about, the first step would be to talk to your employer, see if you have a high deductible health plan that’s HSA eligible. If you do, I think the next step is to open it up and begin contributing. But we work with our clients all the time on this and it’s not always cut and dry, so if you have questions we’re absolutely here to help.

This has been Kari Wolfson, Andrew Busa and Victor Colella from Adviser Investments and we’re thanking you for listening to another Adviser You Can Talk To podcast. If you’ve enjoyed this conversation, please subscribe and review our show. You can also check us out at AdviserInvestments.com/all-podcasts. Your feedback is truly welcomed. We want to hear from you. If you have any topics you’d like for us to explore, we’d happily do a podcast just for you, so please send us an email at info@Adviserinvestments.com if you have any suggestions. Thanks.