Many people understand the need to save for retirement, and many have taken action by contributing to 401k’s and IRA’s. However, what people haven’t connected the dots on is that their largest post-retirement cost is most likely going to be healthcare. Health savings accounts (HSA) are an underused vehicle to help prepare for this inevitability.
Health savings accounts (HSA) were first introduced in 2003 and were designed to help employees use pre-tax dollars to pay out-of-pocket medical expenses but use of these accounts has been surprisingly low.
HSA Purpose and Qualifications
HSAs are very similar to retirement accounts but they have a specific focus (medical expenses).
This tax-advantaged account was developed to help employees off-set high deductible plans offered by their employers.
The health plan offered by individual companies have to be deemed high deductible per the IRS guidelines.
The dollar thresholds have been slow to adjust over time, and many employers have continued to increase the deductible to keep their premiums in-check, so many employees are eligible for this account.
Currently, the IRS defines a high deductible health plan as any plan with a deductible more than $1,350/ individual or $2,700/family.
HSA Investment Threshold
For 2020 the contributions limits are $3,500 of an individual and $7,000 for families. There is a $1,000 catch-up provision for investors over 55.
If you withdraw the funds prior to 65 for non-medical expenses, the distribution will be subject to a 20% penalty and income tax.
If withdrawn after 65 for non-medical expense you will have to pay income tax but not a penalty.
The best path is to reserve for medical expenses where you both avoid tax and penalty.
Why are HSAs such a Strong Investment Vehicle?
It truly does not get any better.
The funds invested in a Health saving accounts (HSA) are done on a pre-tax basis (1), the funds will continue to compound tax-free (2), and can be withdrawn tax-free/penalty-free when used for intended medical purposes (3). Beyond the tax treatment, there is not a forced withdraw at age 70 ½ like traditional IRAs (4).
As an example, a person who contributes $7,000 (max for family) per year for 20 years.
Earning an average return of 7%, she would have accumulated $314,056, which could be withdrawn to pay Medicare premiums, long-term-care insurance, prescription drugs, dental issues, emergency room visits.
If equivalent funds were stowed away in an IRA or 401k, and you were in a 25% tax bracket, you would lose 25% with every withdraw as a future tax obligation.
Best Health Savings Accounts (HSA) 2020
Morningstar ® completed a thorough review at the end of September 2018.
The below investment choices were evaluated across 6 criteria (Assessment, Menu Design, Quality of Investments, Performance, Investment Thresholds).
Those that require a little more explanation:
- Menu Design: do the investment opportunities available cover all core asset classes?
- Quality of Investment: what is the rank of the funds available in each plan? The rank is based on return vs. risk, duration of the fund, overall historic performance, and fees.
- Price: Takes into account the maintenance fees, and marketing fees charged by the companies. Again, lower the better.
Overall, The HSA Authority comes out on top but followed very closely by Bank of America.
I give a slight edge to HSA Authority given that I overvalue the Quality of Investments criterion given this is a long-term investment vehicle for me.
Best Health Savings Accounts(HSA) for Spending
As discussed previously there are two functional purposes for an HSA.
The above is a recommendation if you are saving for future medical expenses, below is the evaluation if you are trying to save for today’s expenses and won’t have the opportunity to let funds compound.
The specific objective here is to minimize account expense and maximize short term interest return received.
The above chart shows the net effect of fees and returns based on dollar amount in the funds.
There are two clear winners. For the lower balance you should go with The HSA Authority where fees are minimized across dollar balances.
If you intend to keep more than $4,000 in the account Fifth Third becomes the winner.
Health Savings Account Rules
As alluded to through the above summary there are specific rules on the expense types that qualify for the tax-free withdraw.
For specifics visit the IRS publication 502 [Medical and Dental Expenses].
For contribution limits, in 2019 it is $3,500 for an individual and $7,000 for family.
Finally, in terms of qualification for the plan, your employer’s health plan offering has to be deemed a high-deductible plan, which currently The IRS defines as any plan with a deductible of at least $1,350 for an individual or $2,700 for a family.
If you qualify for an account, you should absolutely pursue this. The benefits are too great, and the future medical expenses you will incur are almost certain.
The HSA Authority is the clear winner. They won in both the “Today” expense analysis and the best vehicle to compound money for “Future” medical expenses.
Grabbing the top spot in both analysis indicates this company gets it, and has the investors’ best interest in mind.
As things change within this space, both politically and medical care policy-wise, it will be best to partner with a company that has demonstrated care for near term expenses and investment options that allow for diversification across asset classes and good return/cost attributes.
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