Health Savings Accounts, or HSAs, are tax-advantaged accounts for saving for medical expenses. Think of them as a healthcare IRA, where you save money when you are healthy to pay for healthcare expenses when you are sick. If used correctly, individuals can get tax advantages by putting money into an HSA, as opposed to simply saving money in a taxable account and paying for healthcare expenses out-of-pocket. This must be done carefully, and consultation with a tax adviser is a good idea to avoid making a mistake.
Many HSAs allow the individual to collect interest on balances when they exceed a specific amount. Many plans even allow the account holder to invest the money in mutual funds or other assets if the balance is large enough. The question is, however, is investing HSA funds a good idea? The answer is that you should invest some of the money, but not all, and that the amount you should keep readily available depends on your age, family situation, and health.
In deciding how much to invest, one must realize that there are two competing risks involved. The first risk is the loss of money due to a decline in the value of the assets in which the money is kept. If money is kept in cash, CDs, and money market funds, the chances of the value of the assets declining during short periods of time is very small. If you have $100 in your HSA in cash investments and are receiving 1% interest, you have a very good chance of having a little more than $101 in the account in one year, assuming no withdrawals or deposits were made during that time. There is little chance of the money not bring there when you need it.
On the other hand, if the $100 were invested in stocks, the value is a lot less certain. This year stocks increased by more than 20%, so instead of having $101 in the account, you would have $125 or so. There have been times, however, where the value of a stock portfolio declines by 10-15% or more in a very short period of time. You wouldn’t want to go to your HSA for the $1000 you need for a hospital bill, only to find the value of the stocks you held declined and there is only $700 left.
There is another risk, however, that keeps you from just being able to leave the money in CDs and money market funds, and that is inflation risk. Even when inflation is a relatively tame 2-3%, that devaluation of the currency will have an effect over time. At 3% inflation, your savings is cut in half about every 20 years, such that over 40 years the money you started with will buy about 1/4 of what it could when you started. If inflation picks up as it did in the 1970’s, purchasing power could drop much more rapidly. The risk is therefore that your healthcare will cost more than you have saved even though you have the same numerical number of dollars.
The only way to combat this decay of value is to purchase things that will provide a return that will keep up with inflation. Cash assets, such as CDs and money funds, pay at or just below the rate of inflation. Commodities such as gold will keep pace with inflation over long periods of time, but fluctuations in price over shorter periods of time – like a couple of decades or less – make relying on gold too risky. Plus, the best you will do with gold is the rate of inflation. Stocks, and to a lesser extent, bonds are needed for money that will not be needed for a long period of time to prevent value from being eroded away.
So, to review, money that may be needed in the near-term must be kept in liquid assets that have little risk of declining in value over short periods of time. These are cash assets like CDs and money market funds, or just cash. Money that will be held for a long period of time – such as extra money you save to pay for the large healthcare expenses you’ll see in your 70’s – needs to be in stocks and bonds to provide a hedge against inflation. Mutual funds and/or exchange traded funds should be used, as opposed to purchasing individual stocks and bonds, to increase diversification and decrease risk. This is your healthcare, so you’re looking for growth with reasonable safety, not a big return.
The way to address both of these needs is to save enough first to take care of likely immediate medical needs, placing that money in cash assets, and then keep saving for future expenses, placing that money in stocks and bonds through low-cost mutual funds and ETFs. For example, let’s say a 20-year old male starts a job and opens an HSA, either on his own or through the health plan at work. Most men go to the doctor rarely until they are perhaps 35 or 40, so medical costs might be $200 per year between 20 and 40. That individual might therefore choose to save up $10,000 and keep that money in cash assets, then start to invest money in mutual funds above the $10,000 limit. If he has a $3,000 deductible, he would need to have at least three major medical events within a period of a few years to deplete his $10,000 cash balance – a very unlikely event.
A family in their twenties might want to be a bit more cautious since one or more pregnancies are likely. In that case, the couple might want to save up $15,000 or more with a $3,000 deductible since they would plan to pay for a couple of deliveries. After birth, it is also possible that the children may need greater-than average medical care as they go through their first 5-8 years of life, so a higher cash balance should be held. Once the children are past the more risky years and healthy, the couple could relax their cash position a bit. Ideally, they would have continued to build the balance in their HSA all along while the children were young if there were few expensive medical events.
As is the case in retirement, the more aggressively one saves, the more risk can be taken. If a family has $100,000 in liquid assets, both inside and outside of a HSA, they might be able to keep a lower cash balance in their HSA since equities could be sold and used to help cover expenses if needed even if there were a significant drop in the market. A family with only $10,000 in assets would be less able to take the risk. As is always the case, the more money you save, the greater a return you can get on your money while still keeping risks in check.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.