Last month we discussed the benefits of health savings accounts to reduce taxes and pay for qualified medical expenses. But have you thought about putting your HSA to work as an investment tool?
Your HSA can supplement other forms of long-term savings and allow you to self-direct your investments. Your pretax HSA contributions reduce your taxable income, and your payments on qualified medical expenses are not subject to tax. Retirement distributions for nonmedical expenses are taxed as ordinary income, but distributions continue tax-free for medical costs into retirement.
An increasing number of people are discovering that HSAs can be an important tool: According to Devinir Research, the average HSA account balance increased from $1,400 to just over $1,900 in 2014.
A small percentage of HSAs offer mutual funds to participants as an investment option. Mutual-fund supplements are underused, but they can help your HSA balance potentially grow faster than the rate of inflation or health care costs. Like a 401(k), the investment fund lineup is determined by the employer and may limit the number of choices or incur higher fees than average.
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Target-date funds might be an appropriate long-term investment if you’re a person in good health who is using an HSA. TDFs typically allocate more conservatively as retirement approaches and health bills tend to pile up. It’s safe to assume a diversified approach is best with some mix of diversified stocks, bonds and cash.
There are several risks to using investments other than cash in an HSA. You may need to sell growth assets when prices are down, creating a nondeductible loss. Contribution limits might cover just a fraction of out-of-pocket medical costs, and the entire account might require liquidation during a market decline. Finally, a cash or principal protection option most certainly won’t keep up with inflation or rising health costs with today’s low interest rate.
Clients and advisers need to understand the short- and long-term benefits of HSAs. Research investment choices and fee structure to find what works best for your particular situation. You may find this account option adds to your savings while covering medical bills, now and in retirement.
Mark Daly is a partner in the Perpetua Group in Boise. 333-1433. This column appears in the April 19-May, 16, 2017, edition of the Idaho Statesman’s Business Insider magazine.