Barbara O’Neill, Extension Specialist in Financial Resource Management
Rutgers Cooperative Extension
February 2018
A Hierarchy of Financial Decisions
Health Savings Accounts (HSAs) are an account that people can set up to pay for unreimbursed medical expenses such as deductibles, co-payments, and services not covered by insurance. Eligible individuals can establish and fund these accounts only when they have a qualifying high-deductible health plan (HDHP). HSA money gets deposited tax-free, grows tax-free, and comes out tax-free, if used according to IRS regulations. Anything not spent one year carries over to the next year.
About 25% of U.S. workers have HSAs. HSA funds may be put into investments approved for IRAs, such as bank accounts, annuities, certificates of deposit, stocks, mutual funds, and bonds. No matter how many times workers change employers, their account is fully portable. Account owners are immediately and fully vested so that all contributions made by an employer belong to the account holder.
A study published in the Journal of Financial Planning in 2016 found that the tax savings on many employees’ contributions to an HSA increased wealth by more than an employer match on the same employees’ 401(k) contributions. In such cases, perhaps surprisingly, the maximum allowable HSA contribution should be made prior to the employee contributing any amount to his or her 401(k). The higher an employee’s combined tax rate, the larger an employer’s 401(k) match had to be to beat contributing to an HSA first.
At the 2017 Financial Planning Association (FPA) meeting, the author of the study, Dr. Greg Geisler from the University of Missouri-St. Louis, presented research on a hierarchy of steps to maximize wealth. In other words, if people have discretionary income to save or reduce debt, what should they do first?
According to Geisler, Step #1 is to contribute to a matched employer 401(k) retirement savings plan and/or a health savings account (HSA), depending on an individual’s situation. If the tax savings on contributions to an HSA increases wealth by more than an employer match on the same employees’ 401(k), the maximum allowable HSA contribution should be made prior to the employee contributing to a 401(k).
After deposits to a matched 401(k) and HSA, which were called Steps 1a and 1b, Dr. Geisler suggests the following hierarchy as a suggested order of wealth-maximizing actions:
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Step #2: Pay off high-interest debts in order of their after-tax interest rate. For example, various credit cards that charge interest rates in the mid-teens or higher.
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Step #3: Put savings into a 529 higher education savings account if an individual is a resident of a state that offers tax savings for contributions.
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Step #4: Make unmatched contributions to an employer retirement savings account.
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Step #5: Pay off moderate after-tax interest rate debts in order of their after-tax interest rate. For example, low-interest rate credit cards and an auto loan, home equity loan, and student loans.
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Step #6: Make deposits to taxable (non-retirement) accounts.
This hierarchy of financial behaviors is not “set in stone,” however. There may be excellent non-tax related reasons for not following these financial decision-making steps in exact order, such as saving for a house down payment and building an adequate emergency fund.
However, if you have a high deductible health plan and qualify to participate in a HSA, consider it as part of your “financial planning toolkit.” HSAs can be used as both a savings account for out-of-pocket health care expenses and as an investment.
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