Should I prioritize retirement savings inside of my HSA?

Question

This year I switched my family from a traditional PPO plan to a high deductible plan with an HSA. This is a great move for our family. I have been reading about using an HSA as an investment vehicle for retirement, and I am now wondering if I should prioritize saving in my HSA for retirement.

Some details on my situation:

1. Company pays the full premium for the insurance plan, but does not contribute to the HSA.
2. Currently have saved a few thousand in HSA, but also have been using it for expenses.
3. Some health expenses high/fixed - I will currently always meet my $2600 deductible due to prescription medication.
4. Yearly Account fee of Approx $50 in addition to any investment fees in HSA
5. Married with 3 young children. Currently investing in Roth IRAs and Company Roth 401k.

The big advantage of the HSA is clearly the tax free money for health expenses, which will only increase with age as I consider long term care and other expenses.

I am trying to consider the disadvantages of building up a large balance in an HSA. Some that seem significant are:

1. Limited options for investment. I see I can transfer HSA accounts, but there don't seem to be many options on the market. Many accounts seem to provide limited access to investments within the HSA.

2. Inheritance. Passing on an HSA after death is not good, from what i can tell. It immediately becomes taxable income to estate or to non-spouse beneficiaries. Huge advantage here for other IRA options for long-term investments.

Should I be prioritizing building a large retirement balance in an HSA over or alongside Roth and other IRA investments? Should I consider some sort of 'cap' or target value to fund my HSA? Admittedly, at this point there is a good argument for maxing out contributions to all accounts, if possible.

Any insight here is appreciated! Thanks.

Answer 1

Unquestionably I think the priority should be funding retirement through ROTH/IRA/401K over HSA extra. Obviously you need to fund your HSA for reasonable and expected medical expenses. Also there is some floor to your more traditional retirement funding.

Beyond that what does one do with excess dollars? Given the lack of flexibility and fees, it seems clear to do ROTH IRA and 401K.

Beyond that what then? You may want to decide to "take some money home" and pay taxes on it. Do you have a desire to own rental property or start/purchase a business? Upgrade your home? etc...

If all those things are taken care of, only then would I put money into an HSA.

YMMV but most people, maxing a ROTH IRA alone, will have plenty of money for retirement given a reasonable rate of return.

Answer 2

You would want to prioritize Roth and retirement over HSA. As the HSA is only for health and dental expenses, which you will always have, overfunding it will put you in a bit of a pickle for all of the life involved. For example, even if you or a loved one develop a strange & expensive ailment, the HSA will only cover the medical costs, but not any travel to specialists, hotel stays, home alterations, special vehicles, or lifestyle alterations (food, clothing). However, you will eventually stop working even if you are healthy throughout your life.

I would suggest that you treat the HSA as a part of your overall emergency fund, giving it a cap the same as you would normal non-retirement savings. Since you stated you have three young children, small and large medical expenses (such as braces, trips to the emergency room) are something that are almost guaranteed, thus having fairly large amount in the HSA would be very beneficial throughout their time with you. Once the children have left however, if you still have an overwhelming balance in your HSA, you may not want to add anymore to the HSA. Setting a cap for the HSA based off a certain number of years of deductible payments for medication would be a good place to start.

Roth accounts, whether it be within your company's 401k plan or the IRAs for yourself and your spouse, are single-handedly the best location for your money for long-term savings. Roth money grows tax-free, is immune to Required Minimum Distribution provisions, and will avoid estate escrow when going to one's beneficiaries. Even if you tap into the funds prior to age 59 1/2, you would only pay taxes on any investment growth, in addition to the 10% early withdrawal penalty. If you have established Roth IRA accounts and have an AGI that disallows you to further contribute to them, there is still a provision to get Roth funds contributed via conversion through what is commonly called a "back door" Roth.