Managing the risks and rewards of this financial plan.
In my last article I gave you an overview of health savings accounts (HSAs), including who is eligible to contribute and the tax benefits of doing so. Let’s discuss some other aspects of HSAs:
How much can you contribute to an HSA?
The amount you are allowed to contribute depends on several factors:
- Whether you have individual health insurance coverage or family health insurance coverage — Remember either way you must have a high deductible health insurance plan (HDHP). Assuming you have the HDHP for the full calendar year, then for 2019 the maximum contribution is $3,500 for individual coverage or $7,000 for family coverage. Let’s say your combined marginal federal and state income tax bracket is 40%. The pretax contributions to your HSA equate to $1,400 or $2,800 of annual tax savings.
- Age above 55 – Like a 401k or IRA, you are allowed to make a catch-up contribution of $1,000 after you turn age 55. However as stated in my first article, you cannot make this catch up contribution after you enroll in Medicare at age 65
- The number of months in the year you have a HDHP health plan – If you start out the year with a traditional health insurance plan and then later in the year you switch to a HDHP plan, then your HSA contributions can be either of the following:
- Prorated based on the number of months in the year you had the HDHP plan or
- Full HSA contribution as long you maintain the HDHP plan until the end of the following calendar year
- As an example, let’s say you start out the year with a traditional health insurance plan that does not allow you to contribute to an HSA, and then on July 15 of the year you switch to HDHP with family coverage. In this case you can make half of the $7,000 contribution (or $3,500) for the year. Or if you maintain that same plan for the entire next year then you can contribute the entire $7,000 for this year.
- Employer contributions – Some employers will make HSA contributions on your behalf. Usually, I’ve seen employers make around $500 to $1,000 annual employer contributions. The employer will deposit that amount direct into your HSA account. If your employer does make these contributions, then you must make sure that the total combined employer and employee (your own) contributions do not exceed the limits above.
What is the deadline for making HSA contributions?
The deadline for making current year contributions is the federal income tax return deadline (usually April 15 of the following year). What’s nice about this is that if you’re in a situation where you switched health insurance to a HDHP plan during mid-year, then you can calculate your prorata contribution and make that contribution as a lump sum by April 15 of the following year.
What happens to your HSA account funds that remain in the account?
- At the end of the year, your HSA account balance remains as is. Unlike flexible spending accounts (FSA), there is no “use it or lose it” scenario.
- If you change jobs and you no longer have a HDHP plan, then the HSA account still remains. You own the account rather than your employer, so it’s “portable.” Your ability to make new contributions depends on whether your new health insurance is a HDHP plan.
- When you retire you can still keep the HSA, but you can’t make contributions to it after you enroll in Medicare at age 65.
- At death and assuming your spouse is the beneficiary, then your spouse becomes the account holder.
What do you do with the HSA account balance?
You have two options:
- Keep the money in cash – this gives you liquidity so that you can spend it for current year medical expenses. Realize that if you keep the account in cash, then of course the account balance won’t grow. That’s fine if your intent is to spend the money now and not take any risk in the account.
- Invest it – This gives you the chance to defer spending from the account to a later date or you have the option of spending it now as well. What can you invest it in? Just like an IRA or taxable (brokerage) account, you can invest it in individual stocks, bonds, ETFs or mutual funds. The HSA effectively turns into another investment account and that means you’ve got to properly diversify the investments in the HSA just like you would with the rest of your portfolio. Depending on your HSA custodian, you may need to open a separate subaccount for investment purposes. This means that you’ll have the HSA checking account and a separate HSA investment account.
What can the HSA balance grow into?
Assuming you invest the money, the growth of your balance in the HSA depends on your annual contributions, the amount of risk and diversification in the account, and of course the rate of return you get.
Let’s say you are 35, you’re healthy and have a family HDHP health insurance plan every year until you reach Medicare age 65. You make the maximum $7,000 contribution to the HSA every year and you get an average 7% return in the account. Let’s also assume that you let the HSA balance grow and do not withdraw any money from the account for medical expenses until you retire.
Your total contributions equal $210,000 across that 30 year time span. The potential account balance at age 65 is over $660,000. More realistically, even if you use half of the contributions each year for annual medical expenses and save the rest, you’d still have over $300,000 account value at retirement age.
What’s the best part? The original contributions and the growth of $450,000 are both income tax free when used for medical expenses. And remember that you got an upfront tax deduction on the original contributions.
How should I invest the money in the HSA?
This depends on when you spend the money in the account. If you use the balance now, then keeping it purely in cash or perhaps investing in short term high quality bonds may make sense. You probably don’t want risky assets like stocks in case you need the money right when the market tanks.
If your goal is to grow the account and spend it later, then adding riskier assets such as stocks makes sense so you have the potential for a higher expected return.
Next time I’ll discuss additional concepts of the HSA account and some additional strategies.
