I’ve always been a fan of the Health Savings Account. Pre tax? Check. Deducted through your employer before social security taxes? Even better!
As soon as my employer started offering these, I put away the maximum contribution allowed. I did the math, saw a $10,000 out of pocket maximum, then said as long as we don’t have a ton of medical expenses in the first two years, this risk will pay off! At the time, I worked in a state with an income tax and Mrs. Shirts was also working. This meant we was earning below the social security contribution limit, but in a 25% marginal tax rate as a dual income home. On top of federal income tax, we were also paying 6% to the state of Georgia and 6.2% for Social Security. The HSA immediately allowed us to reduce our tax liability while putting away money tax free.
We were fortunate over the next eight years, putting away the maximum each year while not incurring much in healthcare expenses. We also enjoyed one of the best stock market runs in history between 2009 and 2016. Our account quickly grew and before we knew it, we had amassed over $60,000 in the HSA account. Then we ran across the Mad Fientist’s article referring to the HSA as the Ultimate Retirement Account.
I was hooked! I could essentially transfer more and more of my regular savings account into the HSA by just not using the HSA money. On top of it, I started paying for medical expenses with a rewards credit card instead of using my HSA debit card. I started feverishly scanning receipts, logging expenses into a spreadsheet, and grinning with excitement that I found something new! My wife thought I was crazy for going through the hassle of saving $3 receipts.
Unfortunately we had a number of medical expenses occur rapidly and also incurred travel expenses that weren’t covered with our insurance. These expenses were split between two years and we had amassed $17,000 in HSA receipts. I also received a couple notices about investment changes inside my company’s HSA plan and decided to spend some time figuring out exactly how much I was being charged.
Many of us don’t get to choose our vendor for an HSA account, our employer chooses it for us. In our case, we have 100% of our balances invested in an S&P 500 Index Fund and I researched the expenses. You can imagine my shock when I saw a 0.45% expense ratio on an index fund. Compared to the cost I pay at Fidelity, this was 10x higher. I inquired with my employer and plan provider and eventually got the response that instead of charging a flat dollar fee per account, they charge 0.25% to all accounts for record keeping and this causes the underlying expense ratio to go to 0.45%. Great! We were being disproportionately charged for everyone else’s record keeping based on our account size. At this point I start doing math on our options (on a site note, I really didn’t like math until college when I realized you could get a finance degree that involved math with dollar signs).
$17,000 left inside the HSA plan would cost me $76.50 per year at the plan’s current expense ratio
$17,000 invested in ITOT at Fidelity would cost me $5.10 per year in expenses and can be purchased commission free.
Ouch! So was keeping the additional money inside my HSA worth it? This really is a pain to save these receipts, scan these receipts, and log all these receipts?
With Fidelity, ITOT is my favorite investment. This is iShares equivalent to the Vanguard Total Stock Market Index Fund. Since all of these ETF providers are in a race to the bottom, ITOT’s expense ratio is down to 0.03%. ITOT pays a dividend rate of 1.71%, so I know I’ll be liable for the income taxes on these dividends. These are qualified dividends, so I will pay a tax rate of 15%. On $17,000 invested, this equates to $290.70 in dividends. At a 15% tax rate, I will lose $43.61 to taxes, but still come out ahead by $27.79 in my regular account verses my HSA account. The turnover rate is roughly 3%, with a small portion of this being capital gains.
On top of these savings, I am also not worried about the future capital gains taxes or the dividend taxes in retirement. I expect we will keep our joint income level below the $75,000 threashold to receive the benefit of a 0% capital gains tax rate and dividend tax rate. (2018 Update: With the recently passed tax package, this threashold increase to almost $100,000). I will also look at different options to rollover my plan at retirement, but at this time my company doesn’t allow (or understand the concept of) an in-service rollover of HSA funds.
You were right, I was wrong
The statement above is what every good husband needs to learn in a marriage! I sheepishly admitted to my wife that “You were right, and I was wrong” (these are important words to remember in a relationship). I went through the process for filing reimbursements and moved $17,000 out of my HSA account over to Fidelity. Now we pay for medical expenses on a rewards credit card and just immediately file for reimbursement.
I’d encourage everyone to maximize contributions to an HSA for as long as they can, but pay attention to the costs inside these plans. Not all HSA options are equal and you have to determine if you can actually come out ahead by saving receipts. The tax efficiency of index funds are outstanding and it may not be worth the hassle to monitor and save all those receipts.
11/24/2019 Update: We started saving our receipts again once the employer lowered the investment fees in the plan. We’ve subsequently rolled the funds over to Fidelity Investments, they recently started providing fee-free HSA plans to individuals.