I recently signed up for a Health Savings Account (HSA) with my employer. A Health Savings Account is a tax-advantaged medical account which is available to individuals in the US who have enrolled into a high-deductible health plan (HDHP). For 2015, individuals cannot contribute more than $3,350/year, while families cannot put more than $6,650. There is a catch-up contribution of $1,000 for those 55 or older. Individuals who are enrolled in Medicare are not eligible to open an HSA. I signed up for the HSA mainly as another way to defer money for future investment. As most of you know, I am already maxing out other tax-deferred accounts in an effort to cut one of my largest expenses.
An HSA offers a triple tax advantage in most states. The contributions are before tax, which means that the account holder does not pay Federal, State and FICA taxes. If you were in the 25% marginal tax bracket, had a 5% state income tax rate, and you didn’t pay 7.65% for FICA, you will end up saving 37.65% merely by contributing to an HSA account. On $3,350, this comes out to $1,261.27 in tax savings right off the bat. The money can be used for qualified medical expenses at any age, without having to pay any taxes on such withdrawals. However, support documentation should be retained in case of an audit. Withdrawals not for qualified medical expenses are subject to a 20% penalty and income tax. After age of 65, withdrawals are tax-free for any type of distribution from the account.
I was attracted to HSA’s because of the large tax deduction. When I contribute money to a tax-deferred vehicle, I have more money under my control, since I reduce the largest expense in my household budget ( taxes). I have done a similar thing by maxing out 401 (k) and Sep IRA contributions since early 2013. I was also attracted by the fact that money put in an HSA account compounds tax-free. In addition, unlike a Flexible Spending Account (FSA), the money does not have to be used by a certain date. Hence with an HSA the money carries over from one year to the next, and thus stays in the account and could potentially compound over time.
One of the major drawbacks to HSA accounts is the large monthly fees with many providers. When I reviewed different providers, it looks like a minimum account balance that is anywhere between $3,000 - $5,000 has to be maintained in cash, in order to avoid a monthly charge in the range of $2 - $5/month. Many employers tend to cover this amount for their employees, so this is a benefit. However, there are additional fees on each withdrawal, ordering checks to pay for items, opening fees, account closing fees etc. Plus, there are monthly fees if you plan to invest that HSA money into something. This is in addition to the fees for failing to maintain a minimum balance in the account. In addition, most of the investment options are limited to mutual funds, some of which have really high expense ratios that come close to 1%/year.
The one positive thing however is that a person is not stuck with an HSA provider, if their employer offers a crappy HSA provider. One can simply rollover the funds from their original HSA administrator, to the HSA administrator of their choice. This is the thing I plan to do, once I max-out the 2015 contribution. Until then, the money is probably going to stay in cash as it builds up every pay period evenly in 2015.
The other drawback is the low limits on how much one can potentially defer. If limits for individuals are increased to at least match those on IRA or Roth IRA accounts, this would be a good start.
I looked at different providers, and looked at their costs to have an account, and availability of investment options. In my research, I give extra points for companies that are not going to charge me $4- $5/month on a $3,000 - $6,000 balance that takes 1 – 2 years to build up, or at least will not charge me monthly fees after my total balances exceed a reasonable amount of dollars. I am talking about eliminating as much in monthly or annual fees are possible, since some administrators tend to charge you an HSA Bank fee if you have less than $3,000 - $5,000 in a bank, in addition to charging you a monthly brokerage fee. I also wanted to find the broker that would allow me as much flexibility as possible in choosing investments that do not cost me a lot.
My research has identified Saturna Capital as potentially the best options for me. There are no monthly fees, and there is a range of investments such as individual stocks and mutual funds that are available. The commissions are steep at $14.95/trade, and there is an annual inactivity fee of $12.50/$25 for mutual fund/brokerage account. However, if I make at least one transaction per year, this fee is waived. If I end up putting $3,000/year in Saturna Capital and purchase one investment, I will end up paying no more than 0.50% on the total amount invested. Since I plan on building out this HSA account for as many years as possible, I would likely keep maxing out this account, and buying one stock position per year. I will reinvest dividends selectively, and put them to work with the new position. If you like to drip, Saturna Capital charges $1 per reinvestment.
I had never heard of Saturna Capital before, so I did some research. The company is SIPC insured, which is good. The downside is that they seem to require new account-holders to mail in information and forms to open an account, and it cannot be done online. Of course, this is a small price to pay for keeping costs to the minimum, and allowing the maximum amount of compounding free of costs.
The second option I would go with, is Wells Fargo. It looks like HSA accounts with over $5,000 in combines cash and investments do not have a monthly fee assessed. This is good. The not so nice thing is that one is limited to a list of mutual funds only, whose expense ratios are really high. The lowest cost stock mutual fund was an index fund with an annual expense of 0.25%.
The third option could be Fidelity, which charges an annual fee of $48. However, if your household has more than $250,000 in total assets at Fidelity, this fee is waived. Fidelity offers individual stock trades at $7.95/investment, plus it has a decent list of ETF’s or mutual funds with low costs if that’s your route. If you have a 401 (k) with Fidelity that you have contributed to for a while, this could be a good option.
The thing to consider of course is that fees can change if minimum balances are changed as well. Plus, there might be fees assessed if you transfer money from one custodian to the next.
My goal now is to slowly max-out the HSA limit of $3,350 in 2015, and then decide sometime in 2016 on which account to rollover that money to. Although HSA accounts have been around for approximately a decade, the amount of fees charged on them seems very high. Over time, I assume that those fees will decrease. But even if they stayed where they are, Health Savings Accounts make perfect sense for those like me who are looking for another vehicle where they get a tax deduction upfront today, and receiving a tax-advantaged growth of their investments. The real nice part is that after age of 65 I can withdraw the money for whatever reasons I desire, and will not have to pay any penalties (if the money is spent on non-medical expenses, it is taxed at ordinary income tax rates). I have decided that even if I have to end up with an index fund in that Health Savings Account, I would be better off than picking individual dividend stocks in a taxable account. Let me walk you through a hypothetical (made-up) calculation.
I calculated that if I choose to invest $1,000 in an HSA that generates a net annual total return of 7%/year, I would end up with $5,807 in 26 years. This return assumes that no taxes are taken and also assumes fees paid are subtracted from returns ( meaning the gross return is slightly higher). However, if I were to earn those $1,000 from my day job but decided not to put them in an HSA, I would be left with $623.50. This is because I would be paying 25% Federal Tax, 5% State Tax and 7.65% FICA. If I managed to earn an after-tax annual total return of 9%/year for 26 years in a row, my account balance will be $5860. The break-even point will be 26 years. Of course I am not comparing apples to apples here, because an after-tax return of 9% in a taxable account usually requires a return above 10% even at today’s low rates on dividends and capital gains.
To summarize, I believe that HSA accounts provide several benefits to investors who want to build retirement savings, and have exhausted common vehicles such as 401 (k) or IRA's. The first advantage of HSA's is triple tax advantage, because of the deduction for Federal, State and FICA taxes. This leaves more money working for the investor. The second advantage is tax-deferred growth of that capital for decades. The third advantage is that this money can be withdrawn at any time, penalty free if it is for qualified medical expenses. It can also be withdrawn penalty free after the age of 65. The money is taxed after the age of 65 if used for non-medical purposes at the ordinary income tax rates. The drawbacks behind HSA's include fees, low variety of investment options and the fact that annual contribution limits are low. Of course, for those of us who understand the power of compounding, we know that even a small contribution of $3,000/year over a period of a couple decades could turn into a few nice supplement to the retirement nest egg.
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