Help me pick a fund for my HSA in California

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eye.surgeon
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Help me pick a fund for my HSA in California

Post by eye.surgeon » Sat Oct 14, 2017 10:10 pm

I've done my homework here on the special tax circumstances of HSA's in California but as a fairly casual investor I'm still not clear whether I'd be better off choosing Vanguard total stock market or Vanguard total Bond market for my HSA. It's one or the other of these two for me.

For reference I'm 48,high income earner, highest tax bracket, max out my other tax-advantaged accounts, have about $600k invested between 401k, backdoor Roth IRA, and taxable account, and don't plan on touching my HSA money until after age 65, at which point like many high net worth retirees I'm probably getting the heck out of California.

I also am sensitive to not letting the tax tail wag the dog, I don't want to park my HSA money in a low yield investment for the next 20 years only to save half of my opportunity cost in taxes.
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Re: Help me pick a fund for my HSA in California

Post by grabiner » Sun Oct 15, 2017 12:33 am

Since you are investing the HSA for long-term expenses, it should be invested as if it were part of your IRA. Thus, if Treasury bonds fit your investment needs, holding a Treasury fund will reduce your CA tax. You don't have to change your asset allocation to do this; if you hold Total Bond Market in your IRA or 401(k), you can move some money to corporate bonds to keep the same Treasury allocation.

If your HSA provider doesn't offer a TIPS or Treasury fund, or you have some other reason not to use them (for example, you hold all your fixed income in TIAA Traditional Annuity or the TSP G fund), then Total Stock Market is reasonably tax-efficient. It has a low dividend yield, and it is likelythat capital gains will not be taxed, either because you might move out of CA or because CA might change its tax laws.
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Re: Help me pick a fund for my HSA in California

Post by eye.surgeon » Sun Oct 15, 2017 1:45 am

grabiner wrote:
Sun Oct 15, 2017 12:33 am
Since you are investing the HSA for long-term expenses, it should be invested as if it were part of your IRA. Thus, if Treasury bonds fit your investment needs, holding a Treasury fund will reduce your CA tax. You don't have to change your asset allocation to do this; if you hold Total Bond Market in your IRA or 401(k), you can move some money to corporate bonds to keep the same Treasury allocation.

If your HSA provider doesn't offer a TIPS or Treasury fund, or you have some other reason not to use them (for example, you hold all your fixed income in TIAA Traditional Annuity or the TSP G fund), then Total Stock Market is reasonably tax-efficient. It has a low dividend yield, and it is likelythat capital gains will not be taxed, either because you might move out of CA or because CA might change its tax laws.
Thanks much.
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Re: Help me pick a fund for my HSA in California

Post by indexfundfan » Sun Oct 15, 2017 6:24 am

I strongly suggest using treasury bond funds for a HSA in CA.

Using a tax-efficient equity fund like the total market is fine, as long as you stay with the same HSA custodian. If the custodian's fee increases a lot and you want/need to move, the holding will typically have to be liquidated and you will have to pay CA taxes on it. Over the long term, the capital gains on a bond fund is expected to be much less than an equity fund.

Unlike a regular brokerage account, I don't believe HSA custodians perform in-kind asset transfers. Readers, please correct me if I am wrong on this.
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Re: Help me pick a fund for my HSA in California

Post by zonto » Sun Oct 15, 2017 7:11 am

Just like a Roth 401(k)/IRA, you want your HSA fund to be as large as possible in retirement as you may never need to pay tax on the money. Roth accounts and HSA accounts should be 100% equity in accumulation phase, with bonds held in tax-deferred or taxable (municipals). Even if you are taxed on the annual increase because of the weird CA law, you'd still end up with a larger account balance right?
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Re: Help me pick a fund for my HSA in California

Post by BlueRidgePro » Sun Oct 15, 2017 9:35 am

Given that an HSA is a small investment, and one that needs to be in a low risk instrument, the low potential return rate make is not worth the trouble to invest. Keep it in cash. Any small gain is not worth your effort.

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Re: Help me pick a fund for my HSA in California

Post by eye.surgeon » Sun Oct 15, 2017 12:00 pm

BlueRidgePro wrote:
Sun Oct 15, 2017 9:35 am
Given that an HSA is a small investment, and one that needs to be in a low risk instrument, the low potential return rate make is not worth the trouble to invest. Keep it in cash. Any small gain is not worth your effort.
Why does it have to be a low-risk investment? It's part of my overall AA. It could be all VTSAX.

Even In California contributions are pre-tax federally and qualified withdrawals are all completely federal tax free. It's not a ton of money but at $5700/year that's $200k at retirement for me. That seems worth it to me even if it's not as advantaged as other states. Am I missing something?
Last edited by eye.surgeon on Sun Oct 15, 2017 12:31 pm, edited 1 time in total.
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Re: Help me pick a fund for my HSA in California

Post by zoneinfo » Sun Oct 15, 2017 12:09 pm

Do you plan to use your HSA for medical expenses before age 65?

If you plan to not touch your HSA until age 65, like I do, then just plunk the money in the lowest cost diversified fund you can find. My provider offers an insane 500+ random overlapping funds to choose from; but very few with low costs (also no funds from Vanguard). I ended up using the Schwab S&P 500 Index Fund for my HSA and calling it a day.

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Re: Help me pick a fund for my HSA in California

Post by zonto » Sun Oct 15, 2017 12:30 pm

You're exactly right and should ignore that advice. I believe what was meant was that when it's time to use the account, one may want to have it in low-risk investments to preserve accumulated principal (but do not see why this is any different from any other retirement account).

If you aren't going to touch the HSA for decades and are comfortable with the custodian, use it as part of your equity allocation.
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Re: Help me pick a fund for my HSA in California

Post by grabiner » Sun Oct 15, 2017 12:31 pm

zonto wrote:
Sun Oct 15, 2017 7:11 am
Just like a Roth 401(k)/IRA, you want your HSA fund to be as large as possible in retirement as you may never need to pay tax on the money. Roth accounts and HSA accounts should be 100% equity in accumulation phase, with bonds held in tax-deferred or taxable (municipals). Even if you are taxed on the annual increase because of the weird CA law, you'd still end up with a larger account balance right?
Your goal isn't to have the largest balance in your HSA, nor even to maximize your return across all accounts, but to optimize your return across all accounts. If you hold bonds somewhere in your portfolio (to reduce the risk), you want to hold them in the place which gives the best risk reduction for the loss in expected returns. You need more bonds in a traditional IRA than in a Roth IRA to get the same risk reduction, since the IRS will share your gains and losses in a traditional IRA. And among different accounts, you have to look at the cost of holding bonds. If your 401(k) has high-cost bond funds and low-cost stock funds, you don't want to hold bonds there. You have to look at the tax cost to decide whether to put bonds in taxable or tax-deferred. And for the OP, the cost of holding bonds in the HSA is lower than the cost of holding them elsewhere (as long as they are Treasury bonds), which makes the HSA the best place to put bonds.
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Re: Help me pick a fund for my HSA in California

Post by JBNV123 » Thu Nov 08, 2018 1:53 pm

Realize this is an old thread, but just got my first HSA and I'm in California. I appreciate the advice to invest in relatively higher weight of Treasury bonds in the HSA to avoid state tax (and compensating with other retirement accounts to preserve total asset allocation), however, I am wondering if the math should be a little different with an HSA because of the relatively greater potential tax benefit for use for retirement health care costs (entirely federal tax free withdrawal), that I believe would make growth in an HSA more valuable that other accounts - this I am wondering if it the asset allocation in the HSA should actually be closer to one's overall target asset allocation, despite the California tax policy. Would appreciate others' input to this!

[OT comment removed by admin LadyGeek]

Thanks
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Re: Help me pick a fund for my HSA in California

Post by grabiner » Thu Nov 08, 2018 9:25 pm

JBNV123 wrote:
Thu Nov 08, 2018 1:53 pm
Realize this is an old thread, but just got my first HSA and I'm in California. I appreciate the advice to invest in relatively higher weight of Treasury bonds in the HSA to avoid state tax (and compensating with other retirement accounts to preserve total asset allocation), however, I am wondering if the math should be a little different with an HSA because of the relatively greater potential tax benefit for use for retirement health care costs (entirely federal tax free withdrawal), that I believe would make growth in an HSA more valuable that other accounts - this I am wondering if it the asset allocation in the HSA should actually be closer to one's overall target asset allocation, despite the California tax policy. Would appreciate others' input to this!
You can treat the HSA as part of your Roth IRA, which is also growing tax-free.

But it doesn't actually matter much what goes in a tax-free versus tax-deferred account once you adjust for the taxes. If you will retire in a 25% tax bracket, $4000 in a traditional IRA and $3000 in a Roth IRA are exactly equivalent; you'll get the same value from both if you invest them the same way. Therefore, shifting $4000 in the traditional IRA from bonds to stocks, and $3000 in the Roth IRA from stocks to bonds, changes neither your risk nor your expected after-tax return.

Therefore, you should choose the best option in each account. If the only low-cost option in your 401(k) is an S&P 500 index, you should hold US stock there. If the lowest-cost option in your HSA is a Treasury bond fund, and Treasury bonds fit your allocation, you should hold that fund.

If you are saving the HSA for medical expenses in retirement, long-term TIPS have a decent yield and are a good choice; they will outperform inflation through the time you need to spend them in retirement.
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Re: Help me pick a fund for my HSA in California

Post by inbox788 » Fri Nov 09, 2018 3:08 am

I closed my eyes and put it all in SP500 equities (low or lowest fee). I almost never look at HSA account because it's so much trouble. It might increase my equities AA a little bit. If I put bonds in the HSA and had a more visible equity fund, it would make me more nervous. But balanced correctly, it shouldn't make any difference.

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Re: Help me pick a fund for my HSA in California

Post by CalculatedRisk » Fri Nov 09, 2018 4:03 am

grabiner wrote:
Thu Nov 08, 2018 9:25 pm
Therefore, shifting $4000 in the traditional IRA from bonds to stocks, and $3000 in the Roth IRA from stocks to bonds, changes neither your risk nor your expected after-tax return.
I don’t think this is what the op is asking. Op is asking how $X in the HSA should be invested. I think it is appropriate to grow the HSA more quickly with equity than with bonds. Your response suggests that two people with the same risk tolerance/appetite would have two different AAs if one had a Roth IRA and the other didn’t. I’ve never heard of that. If this is the case, can you point me to literature that explains how I should be modifying my AA as I contribute money to the different types of accounts?

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Re: Help me pick a fund for my HSA in California

Post by mervinj7 » Fri Nov 09, 2018 9:23 am

inbox788 wrote:
Fri Nov 09, 2018 3:08 am
I closed my eyes and put it all in SP500 equities (low or lowest fee). I almost never look at HSA account because it's so much trouble. It might increase my equities AA a little bit. If I put bonds in the HSA and had a more visible equity fund, it would make me more nervous. But balanced correctly, it shouldn't make any difference.
Is your HSA held in CA? If so, at the very least you need to look at it once a year to pay state taxes on the distributions.

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Re: Help me pick a fund for my HSA in California

Post by JBNV123 » Fri Nov 09, 2018 1:55 pm

Thanks for the discussion, I guess I'm questioning why TIPS (to avoid state taxes) would be a good choice for the HSA in CA unless TIPS are your preferred asset allocation overall. I would think for the HSA , if one were going to use it to save for healthcare expenditures in retirement with regular retirement (401k -type plan) as a backup , one would want to get the highest appropriately risk-adjusted return probably similar to your preferred overall asset allocation, and that avoiding CA state taxes would not factor into one's choice enough to significantly alter the bond allocation. I think the CA state taxes certainly eat into the returns, but I question why TIPS would be a good choice here. I think TIPS makes the most sense as the bond portion of the HSA investment, but I don't know if I understand why we should go too far out of our way to avoid the probably 9.3% state tax on the 2% of the dividends in a total market index for example.

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Re: Help me pick a fund for my HSA in California

Post by oslocal » Fri Nov 09, 2018 2:36 pm

JBNV,

One consideration is that they don't send you anything to help you track your basis etc. so to the extent you can make your life easier with Treasury investments (incl. TIPS) and they are any part of your AA - that's why people recommend it for your California HSA.
If you didn't sell your investments during the year you will have nothing to report on federal and no adjustments to report on state either.

You will still have capital gains or losses when you sell your TIPS or Treasury funds.
In my HSA and my wife's HSA, the only Treasury option is TIPS.

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Re: Help me pick a fund for my HSA in California

Post by mervinj7 » Fri Nov 09, 2018 6:19 pm

JBNV123 wrote:
Fri Nov 09, 2018 1:55 pm
Thanks for the discussion, I guess I'm questioning why TIPS (to avoid state taxes) would be a good choice for the HSA in CA unless TIPS are your preferred asset allocation overall. I would think for the HSA , if one were going to use it to save for healthcare expenditures in retirement with regular retirement (401k -type plan) as a backup , one would want to get the highest appropriately risk-adjusted return probably similar to your preferred overall asset allocation, and that avoiding CA state taxes would not factor into one's choice enough to significantly alter the bond allocation. I think the CA state taxes certainly eat into the returns, but I question why TIPS would be a good choice here. I think TIPS makes the most sense as the bond portion of the HSA investment, but I don't know if I understand why we should go too far out of our way to avoid the probably 9.3% state tax on the 2% of the dividends in a total market index for example.
In addition to the tax on the dividends, you also need to pay CA state capital gains tax if you ever have to change HSA custodians and have to liquidate the funds. It's similar to a regular taxable account in that sense. However, unlike a regular taxable brokerage account, you won't receive any tax forms (e.g. no 1099-B). :(

I treat my HSA as a extension of my Roth IRA but with the caveat that I only hold Treasury bonds in this account. One can compensate the AA by placing the appropriate amount of corporate bonds in the Roth IRA. For my particular HSA, Fidelity allows almost every investment option available. Thus, I just hold individual auto-rolling Treasury bonds and save on the expenses of a Treasury bond fund. In the end, I tried not to overthink it and opted for this strategy mostly based on convenience (set it and forget it) in terms of annual state tax filings.

What does your current AA look like? Does your current Roth IRA have any bonds in it?

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Re: Help me pick a fund for my HSA in California

Post by grabiner » Fri Nov 09, 2018 11:56 pm

oslocal wrote:
Fri Nov 09, 2018 2:36 pm
One consideration is that they don't send you anything to help you track your basis etc. so to the extent you can make your life easier with Treasury investments (incl. TIPS) and they are any part of your AA - that's why people recommend it for your California HSA.
You still have to track your basis; CA taxes capital gains on TIPS. (NJ, which also does not recognize HSAs, does not tax capital gains on Treasury bonds.)[/quote]
JBNV123 wrote:
Fri Nov 09, 2018 1:55 pm
Thanks for the discussion, I guess I'm questioning why TIPS (to avoid state taxes) would be a good choice for the HSA in CA unless TIPS are your preferred asset allocation overall.
I agree with this. I didn't hold any TIPS when I lived in NJ, so I chose to put a low-yielding stock ETF in my HSA instead of a Treasury fund.
I would think for the HSA , if one were going to use it to save for healthcare expenditures in retirement with regular retirement (401k -type plan) as a backup , one would want to get the highest appropriately risk-adjusted return probably similar to your preferred overall asset allocation, and that avoiding CA state taxes would not factor into one's choice enough to significantly alter the bond allocation.
The HSA doesn't need to mirror your overall asset allocation. Since your HSA, IRA, and 401(k) are all part of your retirement savings, you can combine them for your desired allocation. You should take advantage of the best options in each account; this might mean Treasuries in the HSA and corporate bonds elsewhere, just as it might mean holding only US stock in a 401(k) if the only low-cost option is an S&P 500 index.
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