Maximizing Wealth with Health Savings Accounts (HSAs)

by Amanda S. Pflaum

As employers try to shift health care costs away from the company and onto workers, high-deductible health plans are becoming more common. A high-deductible health plan (HDHP) is a health insurance plan that has lower premiums and higher deductibles than a traditional health plan.  For 2019, a HDHP is defined as a health plan with an annual deductible that is not less than $1,350 for self-only coverage or $2,700 for family coverage and the annual out-of-pocket expenses (excluding premiums) do not exceed $6,750 for self-only coverage or $13,500 for family coverage.

The advantage of an HDHP is that they may result in cost saving benefits for participants through lower premiums and the opportunity to manage increasing health care costs.  Moreover, selecting an HDHP allows the participant to take advantage of the tax benefits of a health savings account (HSA), which can be substantial if managed correctly.

An HSA is a tax-exempt trust or custodial account set up through a qualified HSA trustee to pay or reimburse qualified medical expenses incurred anytime after the date the HSA is established. HSAs are often overlooked as potential tax-favored investment opportunities that can be better than contributing to IRAs or qualified plans.

While an HSA allows account owners to be reimbursed for current out-of-pocket health care expenses tax-free, similar to health care flexible spending accounts, its benefits can be maximized if used to defer reimbursement of current health care costs and save for those in the future. Its first advantage is that contributions are tax-deductible, or if made through a payroll deduction, they are pretax. Second, the annual investment earnings are tax-free. Third, account owners may make tax-free withdrawals for qualified medical expenses. 

To be tax-free, withdrawals must be for qualified medical expenses (defined by IRC Section 213(d)).  Before age 65, account owners face a 20% penalty for withdrawals that are not qualified medical expenses. Starting at age 65, account owners may take penalty-free distributions for any reason.

Unlike health care flexible spending accounts, which have a maximum year-to-year carry-over of $500, HSAs have no limit on carry-overs or when the funds may be used. This means that medical expenses can be recorded at the time of purchase and accumulated during one’s lifetime, and near death, these HSA funds can be withdrawn tax-free to the extent of all those accumulated medical expenses and penalty-free for all of the remaining funds.  If someone lives to 95, that would equate to 25 years of growth with no required minimum distribution, as is the case with a qualified plan or traditional IRA account. 

Even if the account is opened through an employer-sponsored program, all money in an HSA belongs to the account owner. Accounts are held with a trustee or custodian which may be a bank, credit union, insurance company or brokerage firm.

HSAs do have contribution limits. For 2019, an individual may contribute up to $3,500 for self-only coverage and up to $7,000 for family coverage.  This is up from $3,450 for self-only coverage and $6,900 for family coverage in 2018. People over 55 may add another $1,000 as a catch-up contribution each year. 

If the HSA is used in a manner designed to maximize the tax benefits, we generally suggest the funds be invested similar to Roth IRAs if the participant expects to have sufficient qualified medical expenses so that the withdrawals in time will be entirely tax-free.  If the participant expects to use the HSA for tax-deferral and expects that he/she or his/her heirs will need to pay tax on the withdrawals, we would usually recommend that the funds be invested similar to qualified plans or traditional IRAs.

The left side of the following chart shows the order in which we typically recommend Roth IRAs and tax-free HSAs invest in asset classes. On the right side of the chart, you can see the order in which we typically recommend Qualified Plans, Traditional IRAs and HSAs that are expected to have the distributions subject to taxation be invested when possible:

Roth IRAs / Tax Free HSAsQualified Plans /IRAs/ Taxable HSAs
BestEmerging Market EquitiesEmerging Market Debt
High Yield Fixed Income
Second BestEmerging Market Debt
High Yield Fixed Income
Global REITs
Global Infrastructure
Commodities
TIPS
Hedge Fund of Funds
OKUS Equities
Hedge Fund of Funds
Commodities
TIPS
Non-US Equities
Global REITs
Global Infrastructure
Non-US Core Fixed Income
Core Fixed Income
Emerging Market Equities
US Equities
WorstNon-US Core Fixeed Income
Core Fixed Income
Non-US Equities
The information set forth herein is intended to be informational in nature and is not intended to be tax advice. Please consult with your tax adviser or other financial professional for information and advice specific to your situation.
 

We would love the opportunity to speak with you and/or your family about any financial planning questions that you may have. Please contact your RCL Advisor to allow us to help.

Amanda S. Pflaum is a Financial Consulting Manager at RCL Advisors, LLC

CONTACT US

RCL Advisors, LLC

60 East 42nd Street Suite 2400
New York, NY 10165
212-452-5900
www.rcladvisors.com