Gyroscopic Investing

Curious to see how others would decide in this situation. I'll explain what HSAs are for our international friends.

A Health Savings Account is like a retirement account (IRA) in the US whereby you can contribute around $3,000 per year, receive a tax deduction, and when you withdraw the money, it comes out tax-free if used for health related medical expenses, or if you turn 60, then you can withdraw the money for any reason (it basically turns into a Traditional IRA at that point).

Because you can only put around $3k per year into one, and they've only been around for a short period of time, most people don't have much money in them. However, I've been contributing dutifully for a while and thus my HSA is about 10% of my overall portfolio value.

I have two options available. I can keep the money in a High Yield Savings cash account that essentially has no fees, and yields a pretty nice premium over a T-Bill. HSA accounts by credit unions are typically loss leaders because there's a limit to how much one can contribute so if it attracts new members, the Credit Union sees it as a gain. When I started my HSA several years ago it was yielding 5% back when Tbills were around 2% or so. Now it's yielding about 1.25% when Tbills are 0%.

I expect that when interest rates rise, the HSA rate will rise too so there will always be a 1% to 3% rate on top of TBills. It will be NCUA insured which is like the FDIC but for credit unions. I feel that credit unions are safer than commercial banks so I feel the NCUA is safer than the FDIC, although if push came to shove, I'd bet congress would be more willing to bail out the FDIC.

I have another option whereby I can pay a high fee that amounts to approximately a 0.5% expense ratio in order to allow me to invest in a VG Stock Index fund. Then I can use the HSA towards my stock portion of the PP rather than cash.

All 3 options have their own unique failures:

Option 1: I ignore the HSA entirely and don't count it towards my PP. Since it's about 10% of my portfolio this means I'll be very cash heavy overall. This is my least favorite option because I'm healthy and have high earning potential and no debt so I am not risk averse.

Option 2: I use the Cash option and "squeeze" out an extra 1% to 3% over TBills. Since it's 10% of my overall Portfolio, that means I'll still have 15% of my portfolio in actual TBills in my brokerage account for rebalancing purposes. This is an option CraigR will dislike because Cash is supposed to be the "safe" asset that is always there and NCUA-insured is not the same as a T-Bill. Although, there is a higher than risk-adjusted return that comes from the HSA cash account because an NCUA savings account is only going to yield around 0.75% to 1% in current market rates. Again, because HSA accounts are loss leaders at many credit unions.

Option 3: I pay a 0.5% ER and invest in a VG stock index fund. I count this towards my stock allocation of the PP. I dislike this because of the high expense involved. I also dislike it because this is the absolute worst space to keep stocks relative to every other possible position. Here's why it's bad for stocks:

a) While I am healthy, I may get sick or injured and stocks are volatile so if I need to use the HSA to pay for actual medical problems, then I risk a 50% drop in the HSA balance. Technically not awful because even with a 50% stock loss, I'd have plenty of money to cover my High Deductible Health Insurance deductible, but there may be medical expenses not covered by the deductible, or I may have a medical problem that occurs in December and spans January of the following calendar year, thus requiring I pay two deductibles (since they are based on calendar years, mot rolling 12 month periods).

b) While HSAs are tax-exempt when used for medical expenses, they are taxable like a Traditional IRA if you take them out after age 60 for non-medical expenses (you do avoid the penalty though). I feel Traditional IRA/401ks are horrible for stocks because they convert long-term capital gains, that are taxed at at a lower favorable rate, into regular income that is taxed at your marginal rate.

I'm really leaning towards Option 2 although I imagine CraigR will vote Option 1

I set it up as a poll so I can see how others would think as well.

On a side note, I wasted 20 minutes typing this post, and I've wasted hours reading about HSAs and learning how they work and researching custodians. Because of how horribly complex IRS tax code is, people around the country, not just myself, waste hours reading through things trying to find the best way to avoid taxes. That's all an economic loss to society. I could have done something fruitful with those several hours.

If you chose option 1, what would you have it invested in?

If I chose option 1, which is, ignore HSA from the rest of the PP, it would just be in pure high yield cash, which is the same as option 2, except I'm not logging it towards the cash portion of the PP because it's not "safe" as T-Bills.

I have an HSA.  The custodian keeps the first $2K in a money market fund in case I want to draw on the money to pay medical expenses.  The rest of the balance is invested in mutual funds offered by the custodian.  Because HSAs are so new, it's hard to find HSA custodians that allow self-directed investing.

I don't use the HSA for current medical expenses (I haven't even bothered getting the debit card that is associated with the account).  Instead, my HSA is for long-term care expenses that I might incur later in life.  Since qualifying for an HSA requires one to have a high-deductible health care plan, I keep the deductible in a high-yield savings account to draw on when I need it.  I have my high-deductible plan for catastrophic medical expenses and I pay all the small stuff out of pocket.

I don't expect my HSA to cover completely all of the long-term care expenses I might encounter, but I have concluded that long-term care insurance has too many potential problems for me to want to depend on it (long-term care insurance is a topic for another discussion).  Medical expenses for retirees are expected to run in the neighborhood of a quarter of a million in today's dollars (http://www.marketwatch.com/story/health ... 2012-11-15).

My primary strategy of keeping future medical costs down is to live a healthy lifestyle today.  But if I need long-term care in old age, I want to have an HSA to help.  If I happen not to need the HSA, then my heirs will get a windfall.

I have a separate PP implemented in my HSA.  HSABank has a connection with TDAmeritrade.  I leave the cash portion of the PP in HSABank, where it can be used to pay expenses, and the rest is in the three volatile PP assets at Ameritrade.  This program is compatible with their commission-free ETF program, so I only pay transaction fees on the gold ETF.

I've been using HSAs since they were introduced. My first account was with Patelco, they used to pay 5.12%, but then the rate dropped significantly. Currently my HSA is at Adirondack, FDIC-insured 3% APY is the best rate one can get at the moment. However I am thinking about switching to what Xan is doing with HSABank. Besides potentially getting a better yield I could avoid state taxes on my HSA earnings by investing in Treasury ETFs. Yes, California does not recognize HSAs and taxes both contributions and earnings. 

We discussed the advanced topics of HSAs somewhere on the forum, perhaps in the Cash section. I'll just repeat one of the points that make HSAs attractive: after the age of 65 HSA funds can be spent on any purposes without paying penalty. In other words, HSA becomes similar to a traditional IRA: one only pays income tax on withdrawals. This actually makes HSA a good candidate for "deep cash" portion of PP.