Prioritizing investments- HSA goes where?

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gtt561
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Prioritizing investments- HSA goes where?

Post by gtt561 » Sun Feb 16, 2014 3:36 pm

With all things being equal, where should an HSA account be listed? After 401k matching? 2nd overall?
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Re: Prioritizing investments- HSA goes where?

Post by Spirit Rider » Sun Feb 16, 2014 4:13 pm

I personally put it third, but other people may take a different view.

1. 401k to the match
2. Roth to the max
3. HSA to the max
4. 401k to the max
5. taxable

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Re: Prioritizing investments- HSA goes where?

Post by grabiner » Sun Feb 16, 2014 4:45 pm

Contributing to the HSA should take priority over anything except a matched 401(k), because it also gets a match, from the IRS.

If you are in a 25% tax bracket, it costs you $750 to put $1000 in your HSA, and once it is there, it won't be taxed at all as along as you spend it for medical care, so this is as good as $1000 in a Roth IRA. If you are unlucky and are too healthy in retirement to spend the HSA on medical expenses, anything spent on non-medical expenses is taxed at your regular tax rate, which is just as good as a traditional IRA.
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Artsdoctor
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Re: Prioritizing investments- HSA goes where?

Post by Artsdoctor » Sun Feb 16, 2014 8:38 pm

^ Totally agree with David.

HSAs are great investment vehicles.

Make sure you understand the fees associated with the account. And while the vast majority of states recognize them, a few do not (including California). However, if done correctly, they are superb options for investment purposes.

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Re: Prioritizing investments- HSA goes where?

Post by ASUGrad » Sun Feb 16, 2014 9:00 pm

I agree with David as well. Right after 401k match.

And he left out another gift from the IRS. Your FICA taxes. Most tax deferred vehicles defer 'income' taxes. You still pay FICA taxes. You don't on the HSA. So even if you use it on non-health related expenses in retirement it's better than an IRA because you are saving the FICA taxes.

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Re: Prioritizing investments- HSA goes where?

Post by Artsdoctor » Sun Feb 16, 2014 9:15 pm

I'm a doctor. You WILL use up your HSA in retirement, I can almost guarantee it.

But make sure you keep all of your receipts now. You are definitely allowed to reimburse yourself for expenses even in retrospect. I also print-out the list of allowed expenses at the beginning of each year because the definition of "allowed medical expense" has changed over time (narrowed).

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Re: Prioritizing investments- HSA goes where?

Post by bmay » Sun Feb 16, 2014 9:41 pm

Where would it be in your list if it is a post-tax (non-payroll deducted) HSA?

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Re: Prioritizing investments- HSA goes where?

Post by Calm Man » Sun Feb 16, 2014 9:43 pm

I just wonder about something. One day it is conceivable that we will have a national health insurance system like the rest of the world and medical care will be more or less free. I wonder what would happen to the taxation aspects?

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Re: Prioritizing investments- HSA goes where?

Post by Artsdoctor » Sun Feb 16, 2014 9:50 pm

bmay wrote:Where would it be in your list if it is a post-tax (non-payroll deducted) HSA?


You can still deduct your contributions from your taxable income on both federal and state returns (provided your state recognizes HSAs). I still place HSAs very high on the list although the contribution limit is relatively low.

Calm Man, I'm not so sure I could answer that. With the premium US citizens place on individual rights, I cannot imagine a national healthcare system that would exclude a parallel private system, but I would never try to predict the future of healthcare in this country--and I'm in the thick of it.

I can only make decisions based on today's tax laws. I do like the idea of tax diversification: 401s/403s, Roths, HSAs, taxable accounts, etc., because of the inherent uncertainty in future tax laws.

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Re: Prioritizing investments- HSA goes where?

Post by bmay » Sun Feb 16, 2014 9:56 pm

Artsdoctor wrote:
bmay wrote:Where would it be in your list if it is a post-tax (non-payroll deducted) HSA?


You can still deduct your contributions from your taxable income on both federal and state returns (provided your state recognizes HSAs). I still place HSAs very high on the list although the contribution limit is relatively low.


Well, in my state HSAs are recognized, but I know you can't deduct FICA taxes if your contributions are post-tax. Would you place HSA contributions ahead of 401k contributions in that case?

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Re: Prioritizing investments- HSA goes where?

Post by Artsdoctor » Sun Feb 16, 2014 9:58 pm

bmay wrote:
Artsdoctor wrote:
bmay wrote:Where would it be in your list if it is a post-tax (non-payroll deducted) HSA?


You can still deduct your contributions from your taxable income on both federal and state returns (provided your state recognizes HSAs). I still place HSAs very high on the list although the contribution limit is relatively low.


Well, in my state HSAs are recognized, but I know you can't deduct FICA taxes if your contributions are post-tax. Would you place HSA contributions ahead of 401k contributions in that case?


I would. An HSA contribution in your state will reduce your income tax (both federal and state), the investments will grow without tax for decades (hopefully), and you'll take them out tax-free. It is a triple win and there is no other investment vehicle that can claim that.

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Re: Prioritizing investments- HSA goes where?

Post by goodenyou » Sun Feb 16, 2014 9:59 pm

Artsdoctor wrote:
bmay wrote:Where would it be in your list if it is a post-tax (non-payroll deducted) HSA?


You can still deduct your contributions from your taxable income on both federal and state returns (provided your state recognizes HSAs). I still place HSAs very high on the list although the contribution limit is relatively low.

Calm Man, I'm not so sure I could answer that. With the premium US citizens place on individual rights, I cannot imagine a national healthcare system that would exclude a parallel private system, but I would never try to predict the future of healthcare in this country--and I'm in the thick of it.

I can only make decisions based on today's tax laws. I do like the idea of tax diversification: 401s/403s, Roths, HSAs, taxable accounts, etc., because of the inherent uncertainty in future tax laws.


Healthcare will never be "free", and it will come at at an exorbitant cost without rationing. In the current delivery model, we would bring our economy to it's knees with "free" care. We are seeing the unraveling of cost before our very eyes today. Healthcare in other countries in no panacea. HSA need to be carefully examined, and if you are a high utilizer of care, you will come out on the short end. Very deep in the thick of it, too.

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Re: Prioritizing investments- HSA goes where?

Post by grabiner » Sun Feb 16, 2014 10:04 pm

bmay wrote:
Artsdoctor wrote:
bmay wrote:Where would it be in your list if it is a post-tax (non-payroll deducted) HSA?


You can still deduct your contributions from your taxable income on both federal and state returns (provided your state recognizes HSAs). I still place HSAs very high on the list although the contribution limit is relatively low.


Well, in my state HSAs are recognized, but I know you can't deduct FICA taxes if your contributions are post-tax. Would you place HSA contributions ahead of 401k contributions in that case?


Yes, because the income tax deduction is much more valuable than the FICA deduction. (And it's an adjustment to income, not a deduction, so you don't need to itemize to get the benefit, and the reduced income is used for most tax phase-outs.) If your state recognizes HSAs, you're probably getting about 30% back from the IRS and state.
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Re: Prioritizing investments- HSA goes where?

Post by bmay » Sun Feb 16, 2014 10:24 pm

grabiner wrote:
bmay wrote:
Artsdoctor wrote:
bmay wrote:Where would it be in your list if it is a post-tax (non-payroll deducted) HSA?


You can still deduct your contributions from your taxable income on both federal and state returns (provided your state recognizes HSAs). I still place HSAs very high on the list although the contribution limit is relatively low.


Well, in my state HSAs are recognized, but I know you can't deduct FICA taxes if your contributions are post-tax. Would you place HSA contributions ahead of 401k contributions in that case?


Yes, because the income tax deduction is much more valuable than the FICA deduction. (And it's an adjustment to income, not a deduction, so you don't need to itemize to get the benefit, and the reduced income is used for most tax phase-outs.) If your state recognizes HSAs, you're probably getting about 30% back from the IRS and state.


How is that any different from the 401(k) payroll deductions?

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Re: Prioritizing investments- HSA goes where?

Post by grabiner » Sun Feb 16, 2014 10:27 pm

bmay wrote:
grabiner wrote:
bmay wrote:Well, in my state HSAs are recognized, but I know you can't deduct FICA taxes if your contributions are post-tax. Would you place HSA contributions ahead of 401k contributions in that case?


Yes, because the income tax deduction is much more valuable than the FICA deduction. (And it's an adjustment to income, not a deduction, so you don't need to itemize to get the benefit, and the reduced income is used for most tax phase-outs.) If your state recognizes HSAs, you're probably getting about 30% back from the IRS and state.


How is that any different from the 401(k) payroll deductions?


Because you will always have to pay tax when you take the money out of your 401(k), while you can take money out of your HSA tax-free if you use it for medical expenses. The HSA thus behaves like a Roth IRA with a subsidy from the IRS.
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Re: Prioritizing investments- HSA goes where?

Post by bmay » Sun Feb 16, 2014 10:29 pm

grabiner wrote:
bmay wrote:
grabiner wrote:
bmay wrote:Well, in my state HSAs are recognized, but I know you can't deduct FICA taxes if your contributions are post-tax. Would you place HSA contributions ahead of 401k contributions in that case?


Yes, because the income tax deduction is much more valuable than the FICA deduction. (And it's an adjustment to income, not a deduction, so you don't need to itemize to get the benefit, and the reduced income is used for most tax phase-outs.) If your state recognizes HSAs, you're probably getting about 30% back from the IRS and state.


How is that any different from the 401(k) payroll deductions?


Because you will always have to pay tax when you take the money out of your 401(k), while you can take money out of your HSA tax-free if you use it for medical expenses. The HSA thus behaves like a Roth IRA with a subsidy from the IRS.


Ok, that's exactly what I thought, you just worded it a little bit differently than what I've heard before!

Curious though, can you go into a little more detail about the part in bold?

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Re: Prioritizing investments- HSA goes where?

Post by grabiner » Mon Feb 17, 2014 12:05 am

bmay wrote:
grabiner wrote:Yes, because the income tax deduction is much more valuable than the FICA deduction. (And it's an adjustment to income, not a deduction, so you don't need to itemize to get the benefit, and the reduced income is used for most tax phase-outs.) If your state recognizes HSAs, you're probably getting about 30% back from the IRS and state.


Curious though, can you go into a little more detail about the part in bold?


On your tax return, there are two types of subtractions from income: adjustments to income which are on the front page of Form 1040 itself, and itemized deductions which are on Schedule A. Your adjusted gross income is your total income minus adjustments, and your taxable income is your adjusted gross income minus itemized deductions (or the standard deduction if you take it).

If you don't itemize deductions, you don't get the benefit of deductions on Schedule A. For example, many moderate-income homeowners don't get to deduct their mortgage interest, because the interest, plus other deductions such as property tax, income tax, and charity, doesn't add up to the standard deduction.

In addition, many provisions in the tax cost phase out based on adjusted gross income, not taxable income. If you have an extra $1000 of adjusted gross income and an extra $1000 of deductions, your taxable income won't change, but you might lose part of the child tax credit, or part of one of the education credits, so your taxes will increase. And even a few deductions phase out; you can only deduct medical expenses over 10% over your adjusted gross income, so an extra $1000 of adjusted gross income will reduce the amount of your medical deduction by $100.

Adjustments to income avoid both of these issues; you can always deduct them, and they are treated for most tax purposes as if you never earned the income, so they don't affect phase-outs. An important example is the IRA deduction; this is an adjustment to income, not a deduction, so it has the same effect on your taxes as an equal contribution to a 401(k) which would not be counted in your salary. Similarly, an HSA contribution made by payroll deduction never appears in your income, and one made by check is subtracted from your income, so they have the same effect on the income tax (although one made by payroll deduction is also exempt from FICA).
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Re: Prioritizing investments- HSA goes where?

Post by gtt561 » Mon Feb 17, 2014 12:36 pm

Artsdoctor wrote:I'm a doctor. You WILL use up your HSA in retirement, I can almost guarantee it.

But make sure you keep all of your receipts now. You are definitely allowed to reimburse yourself for expenses even in retrospect. I also print-out the list of allowed expenses at the beginning of each year because the definition of "allowed medical expense" has changed over time (narrowed).


Great tip in printing out the allowed expenses each year. Thanks
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Re: Prioritizing investments- HSA goes where?

Post by hoppy08520 » Mon Feb 17, 2014 1:03 pm

Based on the consensus in this thread, I updated the Prioritizing investments wiki page with this advice.

wiki wrote:Investors who are able to place their investments in several different kinds of accounts (such as taxable accounts, 401k, or IRA) need to decide which ones to prioritize. In order to maximize the tax efficiency of a portfolio, the general rule for investing priority is:

1. Company plan (401k, 403b, etc.) up to the company match
2. Health Savings Account, if eligible.[1]
3. Roth IRA or deductible traditional IRA up to maximum contribution limit, depending on personal circumstances and eligibility.
4. Company plan up to maximum contribution limit
5. Taxable investing

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Re: Prioritizing investments- HSA goes where?

Post by goodenyou » Mon Feb 17, 2014 3:51 pm

hoppy08520 wrote:Based on the consensus in this thread, I updated the Prioritizing investments wiki page with this advice.

wiki wrote:Investors who are able to place their investments in several different kinds of accounts (such as taxable accounts, 401k, or IRA) need to decide which ones to prioritize. In order to maximize the tax efficiency of a portfolio, the general rule for investing priority is:

1. Company plan (401k, 403b, etc.) up to the company match
2. Health Savings Account, if eligible.[1]
3. Roth IRA or deductible traditional IRA up to maximum contribution limit, depending on personal circumstances and eligibility.
4. Company plan up to maximum contribution limit
5. Taxable investing


I would put a disclaimer on the HSA associated with a HDCP. You must do your homework first on your utilization of healthcare before you dive into a HSA. It is not a one size fits all investment strategy. There are some that may be better off with a traditional health care plan. If you are healthy, and a low-utilizer, it will be a good investment tool acting like a stealth IRA

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Re: Prioritizing investments- HSA goes where?

Post by FiveK » Thu Sep 14, 2017 10:34 pm

This is based on a discussion in Paying off debt vs. max savings - Bogleheads.org, and picked up here to avoid cluttering that thread with financial math details.

Stipulations
- $5000 loan, paid monthly, due in 1 year.
- The pre-tax amount corresponding to the minimum monthly after-tax loan payment (Excel PMT function) is available - call that "A".
- An extra $100/mo pre-tax is available, either to invest in an HSA or pay down the loan.
- The full (A + $100) is used each month: whatever does not go to the loan goes to the HSA.

Assumption
- The best use of the $100/mo is that which provides the highest HSA balance at the end of the year, by which time the loan will have been paid in full

Adjustable inputs
- HSA investment return
- Loan interest
- Marginal tax rate

Independent variable
- Fraction of the $100/mo used to pay down the loan

Example
HSA investment return = 6%
Loan interest = 7%
Marginal tax rate = 50%

At 7% interest, the minimum monthly loan payment is $432.63 or $865.27 (rounding) pre-tax.
  • If none of the $100/mo goes to the loan, the HSA gets $100/mo. At the end of 12 months the loan is paid and the HSA contains $1,233.56.
  • If all of the $100/mo goes to the loan, the loan is paid in full in month 11 with a $346.43 payment, or $692.86 pre-tax. The HSA gets $0 for the first 10 months, $272.40 in month 11 and $965.27 in month 12. The ending HSA balance is $1,239.03.
Based on this, paying the loan is preferable. Switch the 6% and 7% rates and the HSA is preferable. In fact, using any tax rate <100% the analysis favors putting the entire $100/mo to the item (HSA or loan) with the higher interest rate.

I've tried to lay the details bare so it may be easier for someone to spot any mistakes. If there aren't any, then leaving the current order in Prioritizing investments - Bogleheads seems correct:
  • 2. Pay off high interest debt (a guaranteed high return, the next best thing to free money),
    3. Contribute to a Health Savings Account (HSA) if available (unlike many other tax deductions, there are no income restrictions to contribute to an HSA)

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Re: Prioritizing investments- HSA goes where?

Post by JBTX » Thu Sep 14, 2017 11:58 pm

Calm Man wrote:
Sun Feb 16, 2014 9:43 pm
I just wonder about something. One day it is conceivable that we will have a national health insurance system like the rest of the world and medical care will be more or less free. I wonder what would happen to the taxation aspects?
I guess if that happened, you could still conceivably pull as much as you can out from prior years out of pocket medical expenses, assuming you kept medical receipts over the years.

There are theoretical risks to all of these tax preference investments. While not likely, if income taxes were abolished and we went with a national sales tax, it would stink for all those Roth holders who paid taxes up front. Conversely, if tax rates went up substantially, it would certainly hurt traditional IRA holders. An increase in cap gains rate would hurt taxable accounts. Social security could be means tested, with tax deferred RMD's as part of the means test.

Chances are something will change in the future. Seems to me all you can do is diversify your account types such that any such change doesn't impact your entire portfolio, and also take protective action in advance when such scenarios appear more likely or play out. Typically there is always a "back door" / loophole to minimize the damage.

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Re: Prioritizing investments- HSA goes where?

Post by TravelforFun » Fri Sep 15, 2017 7:32 am

Agree with most. HSA, if you're qualified, should be your next priority after getting the 401K match. Additionally, if you have a long horizon of 20-30 years to retirement, invest your HSA in 100% equity and use other accounts to balance your investment and achieve your asset allocation goal.

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Re: Prioritizing investments- HSA goes where?

Post by JBTX » Fri Sep 15, 2017 9:26 am

I would break the HSA into two parts:

1. Contributing to the HSA - and getting the Federal and possibly the FICA tax break
2. Using the HSA as a long term investment vehicle.

The HSA is basically like a turbo charged traditional IRA upon contribution (turbo charged in that it may get a FICA/medicare break also) and then once contributed transforms into a Roth IRA, as it is never taxed on withdrawal, assuming used for medical expenses.

I Would venture to say that contributing to the HSA may actually rank #1. If you are in a 25% tax bracket, you immediately get a 25%-33% return on your money in that the taxes are avoided. I suspect that short term rate of return in most cases even exceeds the traditional IRA with match.

Beyond that, I would rank keeping the HSA and letting it accumulate over the years as an investment account, vs paying medical bills with it, would rank below Roth IRA and maxing 401k but above taxable investments. My reason for saying that is some of the nominal fees associated with an HSA, and the minor administrative burden of having to save and keep up with receipt paperwork. I fully understand others may not see those are much of a burden.

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Re: Prioritizing investments- HSA goes where?

Post by rocket354 » Fri Sep 15, 2017 10:27 am

FiveK wrote:
Thu Sep 14, 2017 10:34 pm
This is based on a discussion in Paying off debt vs. max savings - Bogleheads.org, and picked up here to avoid cluttering that thread with financial math details.

Stipulations
- $5000 loan, paid monthly, due in 1 year.
- The pre-tax amount corresponding to the minimum monthly after-tax loan payment (Excel PMT function) is available - call that "A".
- An extra $100/mo pre-tax is available, either to invest in an HSA or pay down the loan.
- The full (A + $100) is used each month: whatever does not go to the loan goes to the HSA.

Assumption
- The best use of the $100/mo is that which provides the highest HSA balance at the end of the year, by which time the loan will have been paid in full

Adjustable inputs
- HSA investment return
- Loan interest
- Marginal tax rate

Independent variable
- Fraction of the $100/mo used to pay down the loan

Example
HSA investment return = 6%
Loan interest = 7%
Marginal tax rate = 50%

At 7% interest, the minimum monthly loan payment is $432.63 or $865.27 (rounding) pre-tax.
  • If none of the $100/mo goes to the loan, the HSA gets $100/mo. At the end of 12 months the loan is paid and the HSA contains $1,233.56.
  • If all of the $100/mo goes to the loan, the loan is paid in full in month 11 with a $346.43 payment, or $692.86 pre-tax. The HSA gets $0 for the first 10 months, $272.40 in month 11 and $965.27 in month 12. The ending HSA balance is $1,239.03.
Based on this, paying the loan is preferable. Switch the 6% and 7% rates and the HSA is preferable. In fact, using any tax rate <100% the analysis favors putting the entire $100/mo to the item (HSA or loan) with the higher interest rate.

I've tried to lay the details bare so it may be easier for someone to spot any mistakes. If there aren't any, then leaving the current order in Prioritizing investments - Bogleheads seems correct:
  • 2. Pay off high interest debt (a guaranteed high return, the next best thing to free money),
    3. Contribute to a Health Savings Account (HSA) if available (unlike many other tax deductions, there are no income restrictions to contribute to an HSA)
My only concern with this analysis is that it limits the analysis period to one year, where one can still contribute to the HSA after paying off the loan. This doesn't seem much different than noting that 7% > 6%. Yes, most people would rather earn 7% on their money than 6%.

However, in annual budgeting people aren't often in the special case above, they are more likely in the situation where it's the end of the year and they can EITHER make an additional payment towards a loan without paying it off fully OR put that same money into their HSA.

Say I have $3400 extra at the end of the year and I can choose between putting those funds towards a 7% loan or into an HSA paying 6%. I won't get another chance to put that money into the HSA because it's limited each year, regardless of what I did the previous year. Putting it into the HSA pays less than putting it towards the loan, but if the term of the loan is 5 years, I am earning 7% per year for 5 years on that money, whereas putting it into the HSA means I have the immediate tax savings (which can then go towards the loan, for example, since $3400 -> HSA might only cost me $2500) plus I will earn 6% into perpetuity, so to speak--at the very least for a time that is quite likely to be significantly longer than 5 years.

I think funding the HSA is preferable in in that and other similar much more common scenarios. But the point is a good one and is one that is very often brought up here: everyone's situation is different, and so it depends on timelines, specific expected returns, and of course the psychological preferences of the individual.

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Re: Prioritizing investments- HSA goes where?

Post by FiveK » Fri Sep 15, 2017 11:29 am

rocket354 wrote:
Fri Sep 15, 2017 10:27 am
My only concern with this analysis is that it limits the analysis period to one year, where one can still contribute to the HSA after paying off the loan. This doesn't seem much different than noting that 7% > 6%. Yes, most people would rather earn 7% on their money than 6%.
The result is the same if one looks at multi-year scenarios. The 1 year example was chosen for simplicity, but if one maintains all the inputs except changing the nominal loan period to 5 years, one gets the chart below. Note that applying 0% to the loan allows HSA funding immediately. That still leaves a lower HSA balance at the end of 5 years, vs. paying the loan in 38 months while putting nothing to the HSA, then making larger HSA contributions for the remaining 22 months.
Image

I'll admit this answer is not "intuitively obvious", and would prefer an algebra/calculus proof to "proof by spreadsheet", but unless someone can point out a math error - and that is very possible :? - it seems the rate of return is what matters most.

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Re: Prioritizing investments- HSA goes where?

Post by FiveK » Fri Sep 15, 2017 12:20 pm

FiveK wrote:
Fri Sep 15, 2017 11:29 am
I'll admit this answer is not "intuitively obvious"....
Thinking more, perhaps that's because this differs from a choice of where to invest, e.g., HSA or taxable. With that choice, one can avoid the tax bite by using an HSA, so using the HSA is "obvious".

When one is constrained to a minimum loan payment, however, money used to pay the loan must suffer a tax bite on the way from gross income to loan payment (assuming loan payments come from taxable income). Reducing the gross amount going to the loan, when the loan interest rate is higher than the HSA return, allows more to go into the HSA.

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Re: Prioritizing investments- HSA goes where?

Post by deltaneutral83 » Fri Sep 15, 2017 1:50 pm

I'm not great with detailed explanations because I usually leave something out but a HDHP with HSA works just as well in many cases of people who go to the Dr. once a week and have monthly prescriptions. It's just basic arithmetic in that the difference between the PPO Deduc/prescriptions/co-pays-cpins. vs. the HDHCP max OOP (minus the difference in annual premium between the two plans).

Example- I have a $3,250 individual Max OOP with HDHP (in network). Annual premium savings on HDHP vs PP0 = $1000. PPO plan deduc is $1300. If I think I'm going to spend more than $2250 with the PPO (and this doesn't even factor in the tax advantages of my HSA which I can max out at $3,400) plan on Dr. visits, prescriptions, emergencies (which I can't predict) in the year then the HSA still comes out ahead. One trip with admission on the PPO to the hospital will take care of $1300 deduc on PPO and that's not even getting into co insurance/ prescriptions etc etc.

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