Maximizing tax advantaged room in California HSA

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enadroj
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Maximizing tax advantaged room in California HSA

Post by enadroj » Fri Oct 05, 2018 12:24 pm

I followed the advice in this thread and others to shift my HSA to the Vanguard TIPS fund to minimize tax complexity in California for HSA reporting. However, I've been thinking about this more and I'm wondering if this is optimal despite being in a 11.3% California state tax bracket. We already have and continue to expect to have plenty of qualified medical expenses, we also have the means to pay those expenses out of pocket and save the receipts for future qualified withdrawals. So, this is strictly about how to best allocate the HSA for maximize long-term tax deferral assuming we don't touch the account for 20+ years.

I've been wondering if I should actually be thinking about investment placement in the HSA like I would a Roth IRA - i.e. maximize tax deferred room in the HSA by choosing investments with higher growth potential (despite the potential California tax). I'd still choose an investment that was tax efficient and didn't have lots of distributions (e.g. something like VTI). I'd have CA tax to pay, but it might not be the end of the world given the potential for long-term federal deferral growth.

My decision - should I:
(a) stick with TIPS in my California HSA to simplify taxes, or
(b) pick a fund with relatively good tax efficiency but has longer-term growth potential to expand HSA room (e.g. VTI)

Although I treat the HSA / TIPS allocation as part of my overall fixed income allocation, I probably wouldn't otherwise hold TIPS if it weren't for the HSA (favoring simplicity) - I would just increase the total bond fund that I hold in my 401(k). Thoughts? Comments? Has anyone eschewed the traditional advice of holding TIPS/Treasuries in their California HSA to make more tax deferred investment space?

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Artsdoctor
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Re: Maximizing tax advantaged room in California HSA

Post by Artsdoctor » Fri Oct 05, 2018 12:49 pm

I have never held TIPS in our HSA accounts and had been investing very aggressively over many years in mine (spouse's HSA started a few years after mine and was slightly less aggressively invested). Like you, I have used the HSA accounts as investment accounts and did not reimburse ourselves for many, many years.

The amounts that were, and are, able to be invested in the HSAs are relatively small so the state tax burden has been relatively small as well when it comes to dividends. The accounts have grown exponentially more than they would have had I been using TIPS for investment purposes.

All of that said, you should also know that we have very large carryover losses from tax-loss harvesting throughout the 2008-2009 downturn. California allows you to carryover those losses unlike some other states. Because of those carryover losses, I have been able to sell the appreciated assets in the HSAs in order to reduce the risk and not have to pay state tax on those gains. For this reason, what I have done may not be appropriate for others (for example, for those in New Jersey who are not able to carryover capital losses).

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Re: Maximizing tax advantaged room in California HSA

Post by GuineaPig » Fri Oct 05, 2018 1:35 pm

Like you, we live in California and have an HSA. We have chosen to have an intermediate-term Treasuries ETF (ITE). For me, the big thing is reducing complexity.

I just don't feel like figuring out how much CA-taxable distributions/dividends my HSA investment has every year. My understanding is that with the Treasuries ETF, I don't have to worry about that. All I have to deal with is capital gains taxes when I eventually sell the ETF. That means I only have to figure out my cost basis and when I eventually sell, then I'll figure out things on my CA taxes. But until then, I can essentially ignore the HSA during my annual tax filing.

Long-term, it might make financial sense to have a total market fund in the HSA. But then, I'd have to deal with it every year on my CA taxes, and since the brokerage won't send any tax statement, I'd have to figure it all out myself. Considering the HSA is a relatively small portion of our total portfolio, it's just not worth my time to fuss around. Certainly, I'd understand if others felt differently (or are already paying somebody else to file their taxes anyway and so are not concerned about the extra paperwork).

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Re: Maximizing tax advantaged room in California HSA

Post by mervinj7 » Fri Oct 05, 2018 1:44 pm

GuineaPig wrote:
Fri Oct 05, 2018 1:35 pm
Long-term, it might make financial sense to have a total market fund in the HSA. But then, I'd have to deal with it every year on my CA taxes, and since the brokerage won't send any tax statement, I'd have to figure it all out myself. Considering the HSA is a relatively small portion of our total portfolio, it's just not worth my time to fuss around. Certainly, I'd understand if others felt differently (or are already paying somebody else to file their taxes anyway and so are not concerned about the extra paperwork).
+1 +1. Couldn't agree with you more. The HSA is a small part of our overall portfolio and I would prefer not to deal with any of CA state tax complexities. We keep $1500+ in a Treasury Only Money Market fund (as good as cash) and rest in Treasury bill ladders with auto-roll enabled. That way, we don't even have to keep track of cost basis.

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Artsdoctor
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Re: Maximizing tax advantaged room in California HSA

Post by Artsdoctor » Sat Oct 06, 2018 8:56 am

There is definitely something to said for simplicity. I will say that I was intimidated at first and thought it would be a hassle keeping track of HSA numbers. However, if you already have a taxable account, you're already keeping track of dividends and gains; folding the HSAs into just another taxable account mindset turned out to be much easier than I had thought. In the end, it's just another couple of clicks with Turbo Tax and Quicken; it probably adds about 15 minutes to your accounting.

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mervinj7

Post by mervinj7 » Sat Oct 06, 2018 9:07 am

Artsdoctor wrote:
Sat Oct 06, 2018 8:56 am
There is definitely something to said for simplicity. I will say that I was intimidated at first and thought it would be a hassle keeping track of HSA numbers. However, if you already have a taxable account, you're already keeping track of dividends and gains; folding the HSAs into just another taxable account mindset turned out to be much easier than I had thought. In the end, it's just another couple of clicks with Turbo Tax and Quicken; it probably adds about 15 minutes to your accounting.
But in practice, I don't keep track of my gains and dividends in my taxable account. The broker does that for me. For turbo tax, you can import all information electronically.
With my HSA I used to have to keep account of every fund I bought and then keep track of the cost basis for years. That first year, I made the mistake of having DRIP enabled. That was a huge inconvenience when I needed to liquidate the stocks. After that, I disabled DRIP and then used a speadsheet to keep track of cost basis. It's doable, of course, by who wants the hassle?
Now, I have nothing but 3 month rolling treasury bills and a treasury money market.

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Artsdoctor
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Re: Maximizing tax advantaged room in California HSA

Post by Artsdoctor » Sat Oct 06, 2018 12:40 pm

Mervin,

It is true that your brokerage firm can keep track of a lot. Certainly there won't be any problems with dividend reports. I use the specific lot ID cost basis method for figuring out my capital gains and I have a lot of non-covered securities dating back many, many years; consequently, I can't use Vanguard's calculations for my capital gains/losses calculations. Even for covered securities, I still have to check Vanguard's numbers since I've found mistakes on their end. All of that said, if simplicity is the most important factor, then going with treasuries certainly is an option.

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Re: Maximizing tax advantaged room in California HSA

Post by grabiner » Sun Oct 07, 2018 10:42 am

enadroj wrote:
Fri Oct 05, 2018 12:24 pm
I've been wondering if I should actually be thinking about investment placement in the HSA like I would a Roth IRA - i.e. maximize tax deferred room in the HSA by choosing investments with higher growth potential (despite the potential California tax). I'd still choose an investment that was tax efficient and didn't have lots of distributions (e.g. something like VTI). I'd have CA tax to pay, but it might not be the end of the world given the potential for long-term federal deferral growth.
The opportunity for future growth in the HSA is less valuable than in a Roth IRA. If you hold stock in the HSA and the stock market booms, you may have more in the HSA than you can spend on medical costs, which will cause some of your gains to be taxed.

But even in a Roth IRA, there isn't a strong reason to hold stocks over bonds. If you retire in a 25% tax bracket, $4000 in a traditional IRA and $3000 in a Roth IRA will have exactly the same return if invested the same way, so there is no tax advantage. There is a minor advantage to hold stocks in the Roth IRA; if the stock market booms, stocks in the traditional IRA may force you to take larger RMDs than you need, and may push you into a higher tax bracket. However, I wouldn't pay 0.19% in tax, plus 11.3% of any capital gain when you sell, to use Total Stock Market. (If you don't expect to retire in CA, that reduces the tax cost, since any capital gains will not be taxed.)
Wiki David Grabiner

enadroj
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Re: Maximizing tax advantaged room in California HSA

Post by enadroj » Sat Oct 13, 2018 11:36 pm

Thanks everyone. Very helpful!

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