Should you invest in HSA before an IRA?

4년 전

Many HSA advocates recommend to fund an HSA before an IRA. There are several reasons to recommend this strategy but is this a rule of thumb applicable to all? Let's evaluate

An HSA offers triple tax breaks. Money goes in Tax Free, grows tax deferred and withdrawals are tax free if utilized for medical expenses. It is not bound to a company and can be taken with you if you switch jobs. There is no use it or lose it rule and many HSA providers have started providing good investment options.

Case for investing in HSA

  1. HSA can provide a triple tax break. We are pretty confident that healthcare costs are going to go up and ability to withdraw money tax-free for expenses that are a high likelihood provides a great investment vehicle
  2. Most HSA providers provide investment options on top of just an interest bearing account. That allows money to grow exponentially
  3. If your medical costs are low, this can still allow for taking tax breaks for future medical expenses. If medical costs are very high that they tend to exceed out of pocket maximum, these plans provide a lower cost than traditional medical plans. They are generally worse than traditional insurance only if the costs are predictable and near the deductible amount per year.
  4. Most employers provide some amount of insurance payments. This reduces the amount required to cover high deductible plan even further making HSA even better investment.
  5. There are no RMD (Required Minimum Distributions) for HSA account that IRA suffers from. In this perspective, it behaves like Roth IRA.
If we take a comparison of an investment in IRA, Roth, and HSA and how they perform over a long term from the perspective of taxes and investments. For this, we are going to take the following assumptions.
  • The average tax bracket is 25% now and 30% in future.
  • The timeline is long term (25 Years) and annual growth rate is 8%.
  • The cost of investment or investment options are similar between all three of them
  • You are withdrawing money at the end for non-medical purposes
Invested Amount 5500 4125 5500
Account Growth $ 402,082.67 $ 301,562.00 $ 402,082.67
Amount Withdrawable $ 281,457.87 $ 301,562.00 $ 281,457.87

In the above scenario, we can see that Roth IRA performs better than IRA or HSA and that happens because the income tax rate in future is higher than current. In-Fact, in any calculation where the income tax is higher in future than today, Roth IRA will perform better than IRA.

Now, if we assume the same scenario as above but assume that 30% of money withdrawn is for medical purposes, the table becomes

Invested Amount $ 5,500.00 $ 4,125.00 $ 5,500.00
Account Growth $ 402,082.67 $ 301,562.00 $ 402,082.67
Amount Withdrawable $ 281,457.87 $ 301,562.00 $ 317,645.31


Since the withdrawals for medical expenses are tax-free, if HSA money is used for medical purposes, it provides a better return than IRA. In case it is used for non-medical expenses, it performs similarly to IRA. Generally, any time there is medical expenses involved in HSA, they tend to perform better than IRA. For Roth, it boils down to how much money is used for medical expenses vs non-medical expenses

Key disadvantages of HSA over Roth IRA

  1. Substantial Inheritance Disadvantages - A Roth IRA can be used for estate planning and tax-free inheritance. An HSA, if inherited by your spouse acts same as if owned by you. In case it is inherited by a non-spouse beneficiary, they have to taxes on the market value in the year of your death. Even worst, the paid (but non-reimbursed) expenses of the deceased are also not covered (though unpaid expenses can be paid directly with HSA). Hence, for estate planning, HSA performs like a taxable income for the non-spousal beneficiary. It is suggested to spend HSA money before Roth esp. closer to anticipated living age. Also, for estate planning, it is suggested to name the lower tax bracket beneficiary or a charitable beneficiary for HSA
  2. There is an implicit assumption in above article that you are retiring in the US. In case you are retiring outside of US, it may not be possible (or quite difficult) to reimburse medical expenses. In that scenario, it is suggested to consume HSA funds first before touching IRA or Roth IRA. Although international medical expenses can be claimed in HAS, it is generally quite tricky for exchange rate conversion and drug legality.
  3. Generally, the investment options of HSA are not as flexible as IRA or Roth IRA options. This is getting better with time but even if there is an additional 50 basis point of fund management fee you may have to pay over an IRA, it would negate the complete benefits of HSA


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