A lot has been said about a Health Savings Account (HSA). It is by far the best tax-advantage vehicle created by mankind that allows eligible individuals to divert a portion of their income to an account from which they can reimburse eligible expenses tax-free and efficiently save for present or future health care expenses. If you have not yet taken advantage of an HSA, I highly encourage you to think about it but more importantly, to do your due diligence to evaluate if it would be beneficial for your personal situation.

Becoming eligible is the critical step, but no worries, this essentially means enrolling in an HSA-qualified health plan (referred to as a High Deductible Health Plan – HDHP) and meeting other eligibility criteria. Once you do that you don’t have to open and contribute to an HSA, but failure to do so would result in a big financial miss on your part. Anyways, before I hit the ground running sharing the process I’ve put in place to manage my HSA, let’s cover a few housekeeping items.

Health Savings Accounts

Todd Berkley defines an HSA as a “tax-advantaged account designed to save and pay for certain health-related expenses tax-free”. I agree with that definition; however, I would also add the word “invest”. Some view an HSA simply as a checking account; however, it could be much more than that.

Regardless of how you decide to manage your money an HSA has four (4) unique advantages: 1) contributions are pre-tax (tax-free or tax-deductible), 2) balance growth is tax-deferred (if you leverage investment options,) 3) qualified withdrawals are tax-free and 4) funds roll over meaning they do not expire as is the case of a Flexible Spending Account (FSA).

Contribution Limits

Depending on how you decide to contribute, HSA contributions are either pre-tax or tax-deductible. In my case, contributions are pre-tax via payroll deduction that when coupled with a contribution from my employer, lowers my net out-of-pocket financial responsibility even more importantly my taxable income. This is, in my opinion, the best way to make contributions. The process is fully automated and aligned with my overall strategy of paying myself first.

While this is all great news, the IRS sets annual limits on HSA contributions that change on an annual basis. Current limits for 2018 are set at $3,450 and $6,850 for individuals and families respectively. If both you and your spouse are HSA eligible and are enrolled on a family or two individual HDHP plans, your maximum annual contribution is still subject to the maximum contribution limit set by the IRS.

If you’re not married but living as a couple you each could have a separate HDHP and contribute up to the maximum individual amount which for the most part tends to be higher than the family amount. Whether it is advantageous or not to have two (2) HDHP vs one (1) HDHP (if covered as a family) is something that will vary on an individual case so you’re going to have to figure what is best for you.

My wife stays at home with our boys so our only option was to enroll in an HDHP as a family contract which allows us to contribute $6,850 in 2018 including a contribution of $1,500 made by my employer (effectively lowering my annual contribution down to $5,350). We’ve been maxing out our contributions since 2009 and so far so good.

Distributions

If contributions to an HSA are pre-tax then what happens when you take distributions? Well hold tight, distributions from an HSA are tax-free as long as they are eligible expenses incurred by the individual eligible for tax-free distributions from the HSA account. If you think about it, an HSA has the best of both worlds, you exploit the benefit of investing pre-tax dollars that grow tax-free (Traditional IRA/401(k)) and when it comes down to making withdrawals the money is also tax-free (Roth IRA/401(k)) if it’s used for medical expenses.

The question you need to ask yourself is whether you should take distributions or invest to let your money grow for the future. The decision is ultimately yours but you don’t actually have to choose. You could actually do both which is exactly what I’ve done.

My plan required a minimum balance before being able to invest. I didn’t pay too much attention to it, so the money was essentially growing just based on the money I was contributing. In other words, I was using my HSA as a lousy checking account (still a good choice given that my contributions lowered my taxable income).

In general, we have been a pretty healthy family but as soon as you have kids the story changes. Using tax-free money for health expenses is a great option to have; however, we were intentional where and how we wanted to use those funds. As a result, we used distributions to pay for expenses related to the birth of our two boys. Aside from that usage has been minimal.

Investing

So what do you with your funds once they hit your account. Well, you have two (2) options: 1) let the money sit and do nothing or 2) come up with an investment strategy. The latter was my choice.

My HSA carrier is Fidelity and my plan required hitting a minimum before being able to invest. Hitting the number was easy; however, at that point in my life, I wasn’t intentional about my financial decisions. This resulted in funds on our HSA sitting there for a few years … ouch!!. My situation changed when I discovered the Financial Independence community which triggered intentionality and led to putting my finances in order.

I have been a fan of JL Collin’s stock series and his book called “The Simple Path to Wealth“. I have adopted his suggestions on most of my investment accounts and the HSA was not going to be any different. JL is a big advocate of Vanguard funds, more specifically VTSAX. Our Roth IRAs are at Vanguard where the only fund we own is VTSAX. Fidelity is the carrier of my 401(k) and HSA. Options within our 401(k) are somewhat limited; however, our HSA provides flexibility to invest in different options that also include Vanguard funds aka VTSAX.

When it comes to investing the only thing you can control are fees. Like I said, Fidelity allows investing in Vanguard funds; however, doing so triggers transaction fees. I decided to pursue other options centered around Fidelity funds that similarly to Vanguard have ultra-low fees (expense ratio) and are free of charge (transactions). I did some research and decided Fidelity’s equivalent to VTSAX called FSTVX. The expense ratio of this fund is 0.015% which is actually lower than VTSAX’s at 0.04%.

I’m not here to debate which fund is better between these two options nor to recommend you invest in Vanguard or Fidelity funds. My intent is to share what I’ve done and to at least trigger some thinking on your part. You’re ultimately responsible for your decisions and as long as they’re aligned with your long-term goals then it should all be fine.

Reimbursements

I read this great post about HSAs and also the HSA owner’s manual. These are two great sources of information that I highly encourage you to read multiple times so that you understand all the ins and outs of a Health Savings Account. My biggest takeaway was the topic of reimbursements.

So let’s say that you are in presence of an eligible health expense that could be covered by your HSA funds? You could obviously use the debit card you get when you open the account but what If you left your card at home? well, you would have no choice but to pay out of pocket.

This is not necessarily the end of the world because as it turns out you have the option of being reimbursed as long as the expense is an eligible one (any expense that diagnoses or treats an illness) and you keep the receipt of the transaction. What I didn’t know is that you do not have to reimburse an expense at the time that you incur it (or shortly after). As Todd Berkley states in the HSA owner’s manual:

“You have great fleixbiliy in determining when you reimburse an expense. As long as you retain receipts, you can reimburse an expense tax-free years (even decades) in the future.”

There is nothing stopping you from being reimbursed immediately and enjoy the tax savings now; however, if you want to build your HSA balance for future expenses you can pay for eligible expenses out-of-pocket. You could also use a hybrid approach paying some expenses with HSA funds and others out-of-pocket. The latter represents exactly what we’ve done but doing so required keeping a 95% stock and 5% cash split within our HSA.

Why I Like My Strategy

I have to give a lot of credit to Todd’s book. If it hadn’t been for it, I would have never known all the options that an HSA provides today and tomorrow. If I continue to follow this strategy, I’m hopeful my HSA funds will continue to grow so that I can have a tax-free health fund available for retirement. But what if my balance grows so high (a great problem to have 🙂 ) that I couldn’t possibly spend it all?  Short answer … this is not a problem. As Todd covers in his book:

“Under current law, once your turn 65, distributions from an HSA for non-eligible expenses receive the same tax treatment, i.e. they are included in taxable income, but no penalties apply”

But what if you want to access your HSA funds before age 65?, like I said before, as long as you save the receipts for eligible expenses you paid out-of-pocket, you can reimburse those tax-free at any point in the future. This, right here, is what makes an HSA the most flexible investment account ever.

Let this soak for a minute and think about it. This means that you could get reimbursed tax-free dollars in the future for eligible expenses you made out-of-pocket years back. Once those funds hit your account, there are no restrictions on how you use that money!!!!. In other words, you could make tax-free withdrawals in the future for non-HSA eligible expenses with no taxes or penalties. This would all work as long as you’ve kept receipts for the HSA-eligible expenses you did not get reimbursed for.

Final Thoughts

• I’m not here to argue whether or not you should sign up for an HDHP in order to be eligible to open a Health Savings Account. It is pretty clear what the advantages of an HSA are but it’s up you to decide if this type of account matches your long-term goals.
• If you agree and believe an HSA makes sense to you, then I highly encourage maximizing your annual contribution as an individual or in case of having a family HDHP.
• When it comes to distributions, we continue to use a hybrid approach where we keep 95% of our funds invested in FSTVX and the rest in cash.
• We plan to pay all of our future health expenses out-of-pocket and keep receipts for future reimbursements. This will give us the flexibility to use tax-free dollars on both eligible and non-eligible health expenses.

So what are your thoughts about HSAs? if you happen to have an HSA, what is your long-term strategy?

Until next time … JJ