Treasury funds in an HSA in California

[CFM300]

I'm trying to chose a fund for my Fidelity HSA account. I live in California.

I see people recommending Treasury funds, since dividends from those funds are largely state tax-free.

Fidelity reports the following percentages of income as being from U.S. government securities:

99.90% - Fidelity Intermediate Treasury Bond Index Fund
99.96% - Fidelity Inflation-Protected Bond Index Fund

Thus, if one had $20,000 invested in the first fund, and the annual yield was 3%, that would result in a dividend of $600.

$600 x 99.90% = $599.40, which means that technically $0.60 of the dividend is taxable.

Those of you who live in California and have treasury funds in your HSA, do you...

1. Look up the percentage, add up your dividends, and perform the calculation every year?
2. If so, do you then adjust your California return to include the taxable portion of your dividend, even if it's a tiny amount?

[mega317]

Yes. Yes. I think you can round to the nearest dollar.

[mervinj7]

Those of you who live in California and have treasury funds in your HSA, do you...

1. Look up the percentage, add up your dividends, and perform the calculation every year?
2. If so, do you then adjust your California return to include the taxable portion of your dividend, even if it's a tiny amount?

Neither since I just purchase Treasury bills at auction and set them to auto-roll. All dividends are 100% tax-free for a CA HSA. In my case, I have a auto-rolling ladder of 6 month bills and a recently purchased TIPS bill.

https://www.fidelity.com/fixed-income-b ... ll-program

[CFM300]

Neither since I just purchase Treasury bills at auction and set them to auto-roll. All dividends are 100% tax-free for a CA HSA. In my case, I have a auto-rolling ladder of 6 month bills and a recently purchased TIPS bill.

https://www.fidelity.com/fixed-income-b ... ll-program

Thanks. I've seen you discuss this option in other threads.

I'm trying to decide which option is the least amount of hassle. Calculating and reporting small dividends or setting up a bond ladder, which is something I've never done.

[mega317]

You did the calculation for your example. I don't think it would be any harder than it was to write the post.

[MotoTrojan]

Neither since I just purchase Treasury bills at auction and set them to auto-roll. All dividends are 100% tax-free for a CA HSA. In my case, I have a auto-rolling ladder of 6 month bills and a recently purchased TIPS bill.

https://www.fidelity.com/fixed-income-b ... ll-program

Thanks. I've seen you discuss this option in other threads.

I'm trying to decide which option is the least amount of hassle. Calculating and reporting small dividends or setting up a bond ladder, which is something I've never done.

If your HSA is at Fidelity rolling bills is automatic.

I hold S&P500 in my HSA in CA but bonds are not part of my core AA.

[mervinj7]

Neither since I just purchase Treasury bills at auction and set them to auto-roll. All dividends are 100% tax-free for a CA HSA. In my case, I have a auto-rolling ladder of 6 month bills and a recently purchased TIPS bill.

https://www.fidelity.com/fixed-income-b ... ll-program

Thanks. I've seen you discuss this option in other threads.

I'm trying to decide which option is the least amount of hassle. Calculating and reporting small dividends or setting up a bond ladder, which is something I've never done.

Yes, one day I need to make a complete post/wiki entry regarding this. For now, tomorrow at 3PM, place an order for a single $1k 6 month Treasury bill with auto-roll enabled. See how you like the process and report back to us. Tax-wise, once it's bought and set to auto-roll, you are done since there is nothing to report. Estimated yield is 2.46%.

https://www.treasury.gov/resource-cente ... ctions.pdf
https://www.treasury.gov/resource-cente ... data=yield

[nalor511]

I hold S&P500 in my HSA in CA but bonds are not part of my core AA.

I really really really don't want to track dividends and capital gains for CA to tax inside my HSA, because unlike a regular taxable account, the broker isn't responsible for (and doesn't) reporting any of that. I took mervin's suggestion and stuck with direct treasury bonds, to skip the whole tracking/tax issue.

[Artsdoctor]

I hold S&P500 in my HSA in CA but bonds are not part of my core AA.

I really really really don't want to track dividends and capital gains for CA to tax inside my HSA, because unlike a regular taxable account, the broker isn't responsible for (and doesn't) reporting any of that. I took mervin's suggestion and stuck with direct treasury bonds, to skip the whole tracking/tax issue.

I can appreciate wanting to keep things simple, but if you're investing in treasury bond FUNDS, you're still going to have to keep track of the gains (or losses). If you're buying your treasuries at auction and holding them until maturity, what are you going to do with the dividends? Are you contributing to a Treasure Only Money Market fund or similar? If you're buying 3- or 6-month T-bills at auction, you'll eliminate that bookkeeping but you won't really be able to grow your HSA if that's one of your goals. The auto-roll feature is fine and it's simple to be sure so I can see the appeal; however, if you're young, you might want to consider the opportunity cost of perpetual T-bills.

The concept of keeping CA tax records is more daunting than the execution. It's really not that bad when you get used to it but it's just a matter of your priorities.

[MotoTrojan]

I hold S&P500 in my HSA in CA but bonds are not part of my core AA.

I really really really don't want to track dividends and capital gains for CA to tax inside my HSA, because unlike a regular taxable account, the broker isn't responsible for (and doesn't) reporting any of that. I took mervin's suggestion and stuck with direct treasury bonds, to skip the whole tracking/tax issue.

Understood. I won’t be selling at all (and won’t be in CA forever) so just adding up 4 dividend distributions is pretty low impact.

[nalor511]

I can appreciate wanting to keep things simple, but if you're investing in treasury bond FUNDS, you're still going to have to keep track of the gains (or losses). If you're buying your treasuries at auction and holding them until maturity, what are you going to do with the dividends? Are you contributing to a Treasure Only Money Market fund or similar? If you're buying 3- or 6-month T bills at auction, you'll eliminate that bookkeeping but you won't really be able to grow your HSA if that's one of your goals.

Re: divs, yes, treasury only MMF

Re: HSA not growing as much, yes I suppose that's a tradeoff I'm willing to make in this case, there are other areas in the portfolio where growth can go without such bookkeeping/reporting/taxationi hassle. CA FTB doesn't mess around.

[nalor511]

Understood. I won’t be selling at all (and won’t be in CA forever) so just adding up 4 dividend distributions is pretty low impact.

Agreed, for me it wasn't the dollar amounts, just the having to keep track at all. At this age I guess my brain is full

[CFM300]

Yes, one day I need to make a complete post/wiki entry regarding this. For now, tomorrow at 3PM, place an order for a single $1k 6 month Treasury bill with auto-roll enabled. See how you like the process and report back to us. Tax-wise, once it's bought and set to auto-roll, you are done since there is nothing to report. Estimated yield is 2.46%.

https://www.treasury.gov/resource-cente ... ctions.pdf
https://www.treasury.gov/resource-cente ... data=yield

Thanks for this guidance. You make it sound easy. But I'll have to learn a bit more before I'm comfortable. How do you choose the duration of the bill/bond? How many rungs in the ladder? How easy is it to liquidate if necessary?

Also, a confession: the HSA at Fidelity actually belongs to my wife, so I need to think about what I'm saddling her with if something should happen to me.

Thanks again.

[CFM300]

Agreed, for me it wasn't the dollar amounts, just the having to keep track at all. At this age I guess my brain is full

Exactly how I feel. I already have too much complexity in my life. So even though this new thing is "no big deal," it still feels like a move in the wrong direction!

[Artsdoctor]

Agreed, for me it wasn't the dollar amounts, just the having to keep track at all. At this age I guess my brain is full

Exactly how I feel. I already have too much complexity in my life. So even though this new thing is "no big deal," it still feels like a move in the wrong direction!

The Fidelity auto-roll could not be easier. The recommendation above was to buy 3- and/or 6-month T-bills. Fidelity could not make this easier to do once you get used to it. You'd buy your T-bills, probably at auction since those are auctioned so frequently, and then there will be a box to check for auto-roll. When those bills mature, Fidelity will automatically buy bills of the same maturity when the old bills mature. You'll wind up with a lot of little bills in your HSA but at least you won't have bookkeeping. Unfortunately, you will not be able to turn off the auto-roll feature online; rather, you'll need to call them and have a representative dis-enroll you. However, that's only a small annoyance.

Unfortunately, you (we) live a high-tax state so while I can appreciate your desire to simplify your finances, if you don't master state tax law to some extent, you will pay for that. The price may be worth it to you, but the cost could be somewhat pricey depending on your finances.

[nalor511]

Agreed, for me it wasn't the dollar amounts, just the having to keep track at all. At this age I guess my brain is full

Exactly how I feel. I already have too much complexity in my life. So even though this new thing is "no big deal," it still feels like a move in the wrong direction!

The Fidelity auto-roll could not be easier. The recommendation above was to buy 3- and/or 6-month T-bills. Fidelity could not make this easier to do once you get used to it. You'd buy your T-bills, probably at auction since those are auctioned so frequently, and then there will be a box to check for auto-roll. When those bills mature, Fidelity will automatically buy bills of the same maturity when the old bills mature. You'll wind up with a lot of little bills in your HSA but at least you won't have bookkeeping. Unfortunately, you will not be able to turn off the auto-roll feature online; rather, you'll need to call them and have a representative dis-enroll you. However, that's only a small annoyance.

Unfortunately, you (we) live a high-tax state so while I can appreciate your desire to simplify your finances, if you don't master state tax law to some extent, you will pay for that. The price may be worth it to you, but the cost could be somewhat pricey depending on your finances.

I completely agree that in this case, with HSA taxation as it stands in CA, Fido auto-roll treasuries appear to be the simplest long-term solution to keep my mind at ease

[CFM300]

The Fidelity auto-roll could not be easier. The recommendation above was to buy 3- and/or 6-month T-bills.
...
Unfortunately, you (we) live a high-tax state so while I can appreciate your desire to simplify your finances, if you don't master state tax law to some extent, you will pay for that. The price may be worth it to you, but the cost could be somewhat pricey depending on your finances.

Why 3- to 6-month T-bills, rather than, say, 5-year bonds?

And you're right that having to master state tax laws is essentially inescapable. I just like to whine sometimes.

[mervinj7]

Yes, one day I need to make a complete post/wiki entry regarding this. For now, tomorrow at 3PM, place an order for a single $1k 6 month Treasury bill with auto-roll enabled. See how you like the process and report back to us. Tax-wise, once it's bought and set to auto-roll, you are done since there is nothing to report. Estimated yield is 2.46%.

https://www.treasury.gov/resource-cente ... ctions.pdf
https://www.treasury.gov/resource-cente ... data=yield

Thanks for this guidance. You make it sound easy. But I'll have to learn a bit more before I'm comfortable. How do you choose the duration of the bill/bond? How many rungs in the ladder? How easy is it to liquidate if necessary?

Also, a confession: the HSA at Fidelity actually belongs to my wife, so I need to think about what I'm saddling her with if something should happen to me.

Thanks again.

Don't overthink it. For most folks, an HSA will be a small part of their overall investment portfolio. For me, I just buy 6 month bills. If you buy 6 of them over 6 months, you will have a 6 bill ladder that maintains itself for the long-term. Liquidation is very easy for T-bills, sell them on the open market, and it will settle in 1 day.

Here are your next (suggested) steps.
1. Invest your entire HSA in FDLXX (Treasury Only Money Market). Yield is 2.05% and it's completely headache and tax-free. Fidelity will automatically liquidate this MMF for any withdrawals.
2. Take a breather. Congrats, you can stop right now or go further for more optimal yields.
3. Buy a single T-bill at auction to see how the process works.
4. Take another breather for a week.
5. Sell your single T-bill on the market to see how the process works. (Not necessary IMHO but good to know)
6. Start buying T-bills at auction until you exhaust your investable HSA funds.

[Artsdoctor]

The Fidelity auto-roll could not be easier. The recommendation above was to buy 3- and/or 6-month T-bills.
...
Unfortunately, you (we) live a high-tax state so while I can appreciate your desire to simplify your finances, if you don't master state tax law to some extent, you will pay for that. The price may be worth it to you, but the cost could be somewhat pricey depending on your finances.

Why 3- to 6-month T-bills, rather than, say, 5-year bonds?

And you're right that having to master state tax laws is essentially inescapable. I just like to whine sometimes.

When you're buying T-bills, you're essentially buying a zero coupon bond. Meaning, instead of buying 10 bonds at par (or, 100, $10,000), you'll be buying them at 99.65 (or $9,965), for example. When they mature, the price will be 100 (so your initial investment of $9,965 become $10,000). No interest is actually paid out. If you're buying a 5-year bond, you'll be getting your interest in 6-month intervals. This isn't bad, but then you'll need to re-invest those dividends (where would that be? new T-bills? money market?). All of this is manageable, but you will be accumulating a bunch of small quantity bills and cash. I find it messy but it'll still work just fine.

If you're at the beginning or in the middle of your investing career, your HSA can grow more than you'd think. Some people think of their HSAs as a relatively insignificant portion of their portfolio but you'd be surprised at what it can become in the right market situation. If you're later in your investing life, then treasuries (and safety) become a much more useful tool.

[grabiner]

If you're at the beginning or in the middle of your investing career, your HSA can grow more than you'd think. Some people think of their HSAs as a relatively insignificant portion of their portfolio but you'd be surprised at what it can become in the right market situation. If you're later in your investing life, then treasuries (and safety) become a much more useful tool.

While an HSA can grow, it should still be a relatively small part of your portfolio. If you aren't maxing out your retirement accounts, you should pay current medical expenses from the HSA. If you are maxing out, you can contribute $6000 to your IRA and $19,000 to your 401(k) but only $3500 to your HSA. Thus, if bonds fit your portfolio, you might as well hold the bonds in the HSA for the tax advantage while you are a CA (or NJ) resident.

One exception would be if you have a specific advantage for holding the bonds elsewhere. If you have the TSP G Fund, or TIAA Traditional Annuity, it's probably worth using that fund for its specific advantages, and holding a US stock index in your HSA. (If you do this in NJ, harvest gains in the HSA in years that you harvest losses in other accounts, as NJ doesn't allow capital loss carryovers.)

[CFM300]

Don't overthink it....

Sure, but I need to understand what I'm investing in and why!

6-month bills are preferable to FDLXX because of the higher yield?

I guess I'll need to compare historical returns between FDLXX, a 6-month ladder of bills, and Fidelity's Intermediate Treasury Bond Index Fund.

Perhaps I'll see that the reward of Intermediate fund is worth the extra tax-reporting hassle.

Here are your next (suggested) steps.
1. Invest your entire HSA in FDLXX (Treasury Only Money Market). Yield is 2.05% and it's completely headache and tax-free. Fidelity will automatically liquidate this MMF for any withdrawals.
...

Thanks for those recommended steps. I appreciate it.

[CFM300]

Why 3- to 6-month T-bills, rather than, say, 5-year bonds?

When you're buying T-bills, you're essentially buying a zero coupon bond.... If you're buying a 5-year bond, you'll be getting your interest in 6-month intervals. This isn't bad, but then you'll need to re-invest those dividends (where would that be? new T-bills? money market?). All of this is manageable, but you will be accumulating a bunch of small quantity bills and cash. I find it messy but it'll still work just fine.

Thanks for explaining that. Much appreciated.

[mervinj7]

Don't overthink it....

Sure, but I need to understand what I'm investing in and why!
6-month bills are preferable to FDLXX because of the higher yield?
I guess I'll need to compare historical returns between FDLXX, a 6-month ladder of bills, and Fidelity's Intermediate Treasury Bond Index Fund.

Yes, 6 month T-bills will generally have higher yield than a Treasury Money Market Fund due to the slightly longer duration. However, the current yield is relatively flat/slightly inverted, so there isn't much of a difference between 1 month, 3 month, and 6 month T-bills.

https://www.treasury.gov/resource-cente ... data=yield

[CFM300]

Here's a question that I haven't seen addressed in the California HSA threads...

Why not use a Vanguard California Tax-Exempt Fund? Like VCAIX.

That would provide 100% tax-exempt dividends, thus eliminating all of the tax-preparation issues except upon the sale of shares.

[grabiner]

Here's a question that I haven't seen addressed in the California HSA threads...

Why not use a Vanguard California Tax-Exempt Fund? Like VCAIX.

Because this yields much less than a Treasury fund of comparable risk; the federal tax exemption on the HSA is wasted.

[CFM300]

Why not use a Vanguard California Tax-Exempt Fund? Like VCAIX.

Because this yields much less than a Treasury fund of comparable risk; the federal tax exemption on the HSA is wasted.

Thanks, David. That's what I figured. But the CA fund has actually outperformed the Treasury fund over the last 1, 3, and 5 years.
(10-year returns are not available for the Treasury fund.)

1 yr, 3 yr, 5 yr
4.88%, 2.31%, 3.36% - Vanguard California Intermediate-Term Tax-Exempt (VCADX)
4.64%, 0.92%, 2.15% - Vanguard Intermediate-Term Treasury Index Fund (VSIGX)

I understand that the California fund is riskier, but if I'm comfortable with that risk (I mean, I already use the fund in my taxable account), why not also use it here, in order to avoid the annual tax-filing hassles with dividends?

[mega317]

I understand that the California fund is riskier, but if I'm comfortable with that risk

It's not just about being comfortable with risk, it's the payoff for the risk. If you want to use a fund that is federal tax-exempt in an account that is not subject to federal taxes, you will need to take more risk to match the comparable gains. If you find a treasury fund to be not risky enough for you, I would still hold the treasury fund in the HSA and reduce your treasury exposure elsewhere, for example by holding more corporate bonds in your 401k.

That is way more effort and false precision than I would want.

[CFM300]

It's not just about being comfortable with risk, it's the payoff for the risk.

The payoff in this case would be higher yields AND simplifying my California tax return each year.

If you want to use a fund that is federal tax-exempt in an account that is not subject to federal taxes, you will need to take more risk to match the comparable gains.

To be clear, what I'm looking to do is use a fund that is 100% California tax-exempt in an account that is subject to California taxes.

[grabiner]

Why not use a Vanguard California Tax-Exempt Fund? Like VCAIX.

Because this yields much less than a Treasury fund of comparable risk; the federal tax exemption on the HSA is wasted.

Thanks, David. That's what I figured. But the CA fund has actually outperformed the Treasury fund over the last 1, 3, and 5 years.
(10-year returns are not available for the Treasury fund.)

1 yr, 3 yr, 5 yr
4.88%, 2.31%, 3.36% - Vanguard California Intermediate-Term Tax-Exempt (VCADX)
4.64%, 0.92%, 2.15% - Vanguard Intermediate-Term Treasury Index Fund (VSIGX)

I understand that the California fund is riskier, but if I'm comfortable with that risk (I mean, I already use the fund in my taxable account), why not also use it here, in order to avoid the annual tax-filing hassles with dividends?

You are looking at past performance, which is not an indication of future results. Muni yields fell more than Treasury yields in recent years, which caused munis to outperform Treasuries. Currently, the CA muni fund has a yield of 1.90% (1.98% on Admiral shares, which will take a long time to reach in an HSA), while the Treasury fund has a yield of 2.31%. Thus you expect a higher future return on the lower-risk fund, and both funds avoid the tax issue with dividends. (And both are subject to CA taxes on capital gains where you sell them, as CA taxes capital gains on tax-exempt funds.)

If you want to take more risk with your HSA bond holdings, use longer-term bonds, preferably TIPS. Long-term TIPS yield about 1% above inflation. Vanguard doesn't offer a long-term TIPS fund, but you could buy individual TIPS, or PIMCO's LTPZ.

[CFM300]

...both funds avoid the tax issue with dividends.

Except that the Treasury fund will require that each year I calculate the small amount of reportable dividends and make an adjustment to my California return as described in the OP. That's one of the tasks I'm looking to avoid, and thus what prompted me to ask about using the California fund in the HSA.

If you want to take more risk with your HSA bond holdings, use longer-term bonds, preferably TIPS.

Thanks for the suggestion. I'm not looking to take more risk, just to avoid adding another tax-preparation task each year.

[pojirm]

Yes, one day I need to make a complete post/wiki entry regarding this. For now, tomorrow at 3PM, place an order for a single $1k 6 month Treasury bill with auto-roll enabled. See how you like the process and report back to us. Tax-wise, once it's bought and set to auto-roll, you are done since there is nothing to report. Estimated yield is 2.46%.

https://www.treasury.gov/resource-cente ... ctions.pdf
https://www.treasury.gov/resource-cente ... data=yield

Thanks for this guidance. You make it sound easy. But I'll have to learn a bit more before I'm comfortable. How do you choose the duration of the bill/bond? How many rungs in the ladder? How easy is it to liquidate if necessary?

Also, a confession: the HSA at Fidelity actually belongs to my wife, so I need to think about what I'm saddling her with if something should happen to me.

Thanks again.

Don't overthink it. For most folks, an HSA will be a small part of their overall investment portfolio. For me, I just buy 6 month bills. If you buy 6 of them over 6 months, you will have a 6 bill ladder that maintains itself for the long-term. Liquidation is very easy for T-bills, sell them on the open market, and it will settle in 1 day.

Here are your next (suggested) steps.
1. Invest your entire HSA in FDLXX (Treasury Only Money Market). Yield is 2.05% and it's completely headache and tax-free. Fidelity will automatically liquidate this MMF for any withdrawals.
2. Take a breather. Congrats, you can stop right now or go further for more optimal yields.
3. Buy a single T-bill at auction to see how the process works.
4. Take another breather for a week.
5. Sell your single T-bill on the market to see how the process works. (Not necessary IMHO but good to know)
6. Start buying T-bills at auction until you exhaust your investable HSA funds.

This sounds like great advice, and I am at Step 2 looking at Step 3

I understand that the difference between the par value (or face value) of a T-bill and the price I paid for it is the interest, that is realized when the bill matures. Say, I buy a T-bill on 11/18 for $X that matures on 2/20, I'll get $1000 on 2/20 and the interest would be $1000-$X. This interest is subject to federal taxes but exempt from state and local taxes. (And in my case, no tax reporting is necessary since I'm looking to put this in my HSA account).

I have two questions:

1. I read that capital gains need to be reported, but I'm not sure what in this case counts as capital gain. If I buy a T-bill, hold it to maturity, and let the matured $1000 sit in my HSA (in a treasury only money market fund e.g. FDLXX), do I incur any capital gains?

2. Looking ahead at step 5 - what does "selling a T-bill" mean here? Once I buy a T-bill, can it be "sold" before it matures?

[nalor511]

This sounds like great advice, and I am at Step 2 looking at Step 3

I understand that the difference between the par value (or face value) of a T-bill and the price I paid for it is the interest, that is realized when the bill matures. Say, I buy a T-bill on 11/18 for $X that matures on 2/20, I'll get $1000 on 2/20 and the interest would be $1000-$X. This interest is subject to federal taxes but exempt from state and local taxes. (And in my case, no tax reporting is necessary since I'm looking to put this in my HSA account).

I have two questions:

1. I read that capital gains need to be reported, but I'm not sure what in this case counts as capital gain. If I buy a T-bill, hold it to maturity, and let the matured $1000 sit in my HSA (in a treasury only money market fund e.g. FDLXX), do I incur any capital gains?

2. Looking ahead at step 5 - what does "selling a T-bill" mean here? Once I buy a T-bill, can it be "sold" before it matures?

1. no capital gains, the "gains" here are actually interest.
2. you can actually skip this one, if you use fidelity's auto-roll program, but yes, you can sell before maturity, I never did so, so I don't know how it works or where you take the hit (presumably there would be one somewhere). I just auto-roll, set it and forget it.

[retired@50]

What about buying stock that doesn't pay a dividend in a CA HSA? Like Berkshire Hathaway B shares or Facebook or Amazon....???

Thoughts?

Regards,

[grabiner]

What about buying stock that doesn't pay a dividend in a CA HSA? Like Berkshire Hathaway B shares or Facebook or Amazon....???

You will still owe tax on the capital gain when you sell the stock (if you still live in CA at the time). Also, some stocks which do not pay dividends now might start paying dividends in the future; Microsoft is a good historical example.

The advantage of Treasuries is that the dividend is tax-exempt, and the capital gain upon sale will be very low. (In NJ, the capital gain is not taxed.)