At an orientation session for my first real job out of college, many (many) years ago, an HR manager explained to our new hire class the benefit of investing in the company 401(k) plan. For a 20-something living paycheck to paycheck, seeing any dollar amount, no matter how small, disappear into an investment vehicle instead of finding its way safely into my checking account was a tough pill to swallow. But upon seeing examples of how a relatively small investment now could translate into pretty large future savings, and the difference that even a few years’ head start can make when accounting for investment returns and the effect of compounding interest, I was sold. And, a few years after my first encounter with serious retirement planning, I encountered another equally valuable retirement savings tool: the Health Savings Account (HSA).
HSAs deliver key advantages of 401(k)s and FSAs, plus more
On the financial side, HSAs function much like 401(k)s or Individual Retirement Accounts (IRA), in that they allow employees and/or employers to contribute to individual savings accounts, pre-tax, and realize tax-free investment returns on those contributions. On the healthcare side, HSAs are similar to flexible spending accounts (FSAs), in that funds can be withdrawn, tax and penalty-free, to pay for routine healthcare expenses. Because HSAs must be used in conjunction with a qualified high-deductible health plan (HDHP), the ability to easily access funds from the account to offset the higher deductible obligation is an important feature for those concerned about the increased out-of-pocket risk compared to a regular PPO-style plan.
But a key advantage of HSAs relative to FSAs is that funds contributed to an HSA carry over year to year, and can accrue over time to create a valuable source of future retirement income for the HSA account holder. FSAs, in contrast, are designed as a short-term benefit to cover the duration of the health plan year.
Factors to consider when looking at an HSA
Many employers contribute to employee HSAs to help jumpstart the account balance and provide immediate relief for the higher deductible, making it even easier to justify the leap to an HDHP/HSA combo.
With that said, decisions around the best benefits option will certainly vary based upon the unique needs of an employee and their family. Many colleagues and clients I have worked with over the years were fully appreciative of the retirement savings opportunity offered up by the HSA, but were willing to sacrifice that benefit for the predictability of a lower deductible plan. Others had personal health situations where the cost of their regular medical expenses outweighed the immediate and long-term savings benefit tied to an HSA/HDHP.
The case for investing HSA funds
Just as the best benefits decision will vary depending on an individual’s particular situation, so too will any investment decisions associated with an HSA. This includes decisions around how to invest HSA funds (those with a higher probability of near-term medical expenses may want to invest more conservatively, for example, whereas younger HSA account holders with limited health risk may opt for more aggressive investment options), as well as decisions on how to allocate and prioritize investments in an HSA relative to an individual’s other investment vehicles. I personally believe, for instance, that there’s a strong argument to be made for maxing out an HSA before maxing out a 401(k) beyond the employer match. That’s because an unexpected medical hardship is one of the biggest if not the biggest potential financial pitfalls for individuals of all ages, income levels, and health profiles – and HSAs are a much better safety net compared to other investment vehicles in that respect. It’s true that Individuals can withdraw funds from a 401(k) without penalty, in some cases, in the event of medical hardship, but the requirements and process can be burdensome and the individual will still pay taxes on the amount withdrawn. Compare that to an HSA, where funds can be quickly and easily withdrawn for any qualified medical expense penalty and tax free. If one should happen to find themselves in the unfortunate situation of having a large, unexpected medical expense to cover, being able to pull from an HSA before tapping into other investments is clearly an advantage.
Seek expert guidance from a financial or benefits advisor
Identifying the ideal solution for financial and healthcare benefits is best accomplished with the support and expert guidance of a financial or benefits advisor. For more information about HSAs and answers to frequently asked questions, visit our Help Center.