42 - How to invest in a Health Savings Account (HSA)

Mental Models discussed in this podcast:

• Tax Shelters

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How to invest in an HSA - Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode42

What is a Health Savings Account or HSA?

• High Deductible Health Plan Definition:
  • Minimum annual deductible of $1,350 (single) or $2,700 (family) based on 2019 requirements
  • Maximum out-of-pocket expenses of $6,750 (single) or $13,500 (family) based on 2019 requirements
• Contribution Limits:
  • Individuals = $3,500 per year
  • Family = $7,000 per year
• HSAs or Health Savings Accounts are tax shelters designed for maximum benefits when used to cover medical expenses.
• These limits and requirements can change on an annual basis. 

Health Savings Accounts are the best tax shelter for employees in the United States of America

• Triple Tax Savings:
  • Up-front tax deduction (Traditional IRA benefit)
  • Tax-deferred growth (Tradition and Roth IRA benefit)
  • Tax-exempt withdrawals (Roth IRA style benefit)
    • Only when used for qualified medical expenses
• The only tax shelter that avoids payroll taxes (Social Security and Medicare)
  • Equivalent to 7.65% for individuals and 15.3% for self-employed workers. 
  • Must use paycheck withholding for deposits

Documentation Management is critical for HSAs

You will want a detailed set of documentation for each of your medical expenses. I use a spreadsheet to collect a master data sheet to track ongoing and past expenses since I opened my HSA. 

I also keep scanned copies of my Explanation of Benefits (EOB), Invoice, and payment receipts for each medical expense. 

I make no guarantees that this is sufficient documentation. Consult a tax lawyer or CPA. 

Cash Buffer Planning

Have a cash buffer of at least 1 full year of "maximum out of pocket expenses" as defined by your health insurance plan before investing your HSA savings. 

This cash buffer allows you to weather any volatility in the portfolio. 

An even better buffer would be 2 full years of "maximum out of pocket expenses" because this prevents the problem of a December injury or illness running into January and maxing out two years worth of health expenses. 

Maintain this cash buffer throughout the investing process

Consider avoiding illiquid stocks

• While I normally find illiquid stocks to offer increased opportunity, you should consider carefully the additional risks this involves for HSA based investing. 
• I place my highest liquidity stocks in my HSA, but otherwise, manage them like a traditional or Roth IRA in terms of stock selection.  

Summary

A health savings account is the best tax-advantaged account currently available for workers in the United States. Thus, it is important to have a plan and understanding of how to invest your HSA money and maximize the benefits of this unique tax shelter.

References

• https://www.irs.gov/irb/2019-22_IRB#REV-PROC-2019-25
• https://www.forbes.com/sites/ashleaebeling/2019/05/29/irs-announces-2020-health-savings-account-limits/#284466d43f3c
• http://www.hsacenter.com/how-does-an-hsa-work/2019-hsa-contribution-limits/