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Should You Use Your Employer’s HSA Custodian?

Written by Nickel - 22 Comments

I’ve written in the past about how unhappy I am with my employer’s choice for our HSA custodian. In terms of accounts fees and service, they’re fine. When it comes to investment options, however, they’re awful. Every single fund has a load and a high expense ratio.

All of this got me to thinking about going out and finding my own HSA custodian. In this case, I would contribute directly to the HSA instead of having the contributions withheld from my paycheck. It’s a bit more work, but it would be well worth the trouble in terms of better investment choices.

Well… It’s time to make a decision, as open enrollment for 2011 benefits is now in full swing. One thing that I’m pretty certain of is that we’ll stick with the high deductible health plan, as that worked out quite well in 2010.

Income tax implications

But what about the tax implications of doing this? According to the US Treasury (here and here) your contributions are tax deductible either way.

If your contributions are taken out on a pre-tax basis, you won’t have any income taxes withheld on those amounts during the year, and those deductions will be reflect on your W-2 at the end of the year. If, on the other hand, you choose to make the contributions yourself, you can take a tax deduction for this amount at the end of the year.

What about Social Security?

But here’s a wrinkle I hadn’t thought of… By having you contributions withheld by your employer, you’ll avoid paying FICA-OASDI and FICA-HI taxes(Social Security and Medicare, respectively). If, on the other hand, you make the contributions yourself, you’ll still be on the hook for these taxes.

So… While you’ll get a federal income tax break either way, you’ll save an additional 7.65% by having your employer deduct your contributions from your paycheck.

Our contribution solution

Given the above, I think I’ve settled on a workable solution. My current plan is to keep an account with my employer’s HSA custodian and also open one with a more investor-friendly custodian. I’ll continue funding the former account via payroll deduction and will periodically transfer funds out to the latter account.

The only possible gotcha with this strategy would be if there are restrictions on, or fees associated with, transfers to a new custodian. I still don’t have full details on this, but even if I did you should check this out for yourself as different custodians likely have different policies.

Of course, if you’re not planning on using your HSA as an investment vehicle, then this will be a non-issue. But if you are, you should pay close attention to both your investment choices and the tax implications of how you fund your account.

Published on October 27th, 2010 - 22 Comments
Filed under: Insurance, Saving & Investing, Taxes

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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22 Responses to “Should You Use Your Employer’s HSA Custodian?”

  1. 1
    Marshall Says:

    My company has Fidelity as it’s investment bank and I’m am pleased with the options that are available for my funds. To be honest though, I wish the would use Vanguard because of the lower fees.

  2. 2
    David Bibby Says:

    I’m just beginning to get the details of my HSA from my employer. I’m still debating as to whether or not the HSA option is better than my current PPO option. I’m not sure I’m ready to make the leap yet. Must do more research.

  3. 3
    Andrew Says:

    actually, FICA is withheld on gross compensation. you pay FICA taxes first, then calculate your withholdings, then pay income tax on the balance.

    The advantage of having it taken out per paycheck is the interest you could be collecting on your tax refund money that you would get when you claim your HSA contributions on your tax returns.

  4. 4
    BG Says:

    Nickel: wow, didn’t realize that the HSA contributions (withheld via employer) weren’t taxed for FICA-MED and FICA-OASDI.

    Just icing on the cake.

    My HSA balance stays near $0, even though I am fully funding it — so the limited investment options doesn’t affect me.

    Still waiting to see the 2011 plans here, so I can run the numbers and see if it is worth it for another year.

    David: No doubt, using the HSA is a pain — you need to keep track of all receipts in case of an IRS audit, etc. Not to mention the high deductibles that must be met before the insurance co. kicks in a single penny. But it can pay off big time due to lower premiums (for the High Deductible plan), and especially the huge tax savings.

    From my number-crunching, these plans are ideal if you have kids (the more the better), and you are fully-funding the HSA account to maximize the tax benefits. In our case, this plan has a lower ‘total’ cost than all the other options, regardless of having $1 in medical bills, or $1million in medical bills.

    Crunch your numbers and make a nice informed decision.

  5. 5
    BG Says:

    #3 Andrew) I disagree. Looking at my paystub, I am not paying FICA or MED on my HSA contributions. I’m effectively saving 32.65% taxes on all my HSA contributions (I’m in the 25% marginal bracket).

  6. 6
    Andrew Says:

    I stand corrected: http://www.ustreas.gov/offices.....shtml#hsa5

  7. 7
    Lulu Says:

    My employer offers the High Deductible plan with the HSA option but they do not offer the HSA. I had to use my own custodian and luckily Chase took care of it.

  8. 8
    Nickel Says:

    Andrew: Yup, my original intention was to link that page as one of the two Treasury links in my article, but I accidentally duplicated the other link. Fixed now. Thanks.

  9. 9
    Steve Says:

    I am trying to decide if I should sign up for my employers HDHP, and if I did, where I should put my HSA. In my case the HDHP is actually more expensive than the PPO option. It might still be worth it because I so rarely visit the doctor for anything more than an annual checkup. But on the other hand, if I did have any medical expenses, the HDHP would definitely end up costing me more.

    Is it really true that only HSA contributions through your employer get the FICA and MED deduction? That’s lame – no wonder employer-related HSA accounts tend to be crummy (though to be honest, most HSA accounts are rather crummy – you’re lucky if you get away with only $25/year in fees for a basic savings account. And another $25/year if you want to invest the money.)

  10. 10
    Joe Says:

    Any recommendations for an HSA custodian?

    Also, if you’re a high earner you don’t have to worry about losing the FICA OASDI deduction if you make the HSA contributions yourself. If you make more than $106,800 you’ll pay the max FICA OASDI anyway.

  11. 11
    Mase Says:

    One question I’ve always had about switching from my employer’s HSA custodian is how the premium pass-thru would work. I get $125 of my premium every month put into my HSA by my employer (thus reducing the amount I need to fund my HSA by $1500 every year as I max it out).

    Is I switched to another custodian, does anyone know how the pass-through would be affected (if at all)?

  12. 12
    T S Says:

    I use my employer’s HSA through 1st HSA (www.1hsa.com). Note: 1st HSA now uses a different tier interest rate than most. The tier for over $10,000 pays 2.25% but on a $12,000 balance they pay what equates to an average of 1.46% (not bad but not 2.25%) e.g. the first $2,000 earns .25% the next $3,000 earns 1.25%, and the next $5,000 earns 1.75%, only the amount over $10,000 earns the 2.25%. 1st HSA used to pay 2.25% on the total balance as long as it was over $10,000. 1st HSA does have a range of mutual funds to invest into, but I have not yet had time to study them in detail.

    I also use Equity Trust Co. as an HSA custodian. I did a partial transfer from my employers HSA (1hsa.com)to set up a self directed HSA (trustetc.com) where I use the funds to lend out for real estate notes. A self directed HSA is not cheap in fees but allows for the most flexible investment choices. Within a few more years I may look at a rental property to purchase with the HSA money, whereby the rent coming in would essentially pay the deductible if anything where to happen.

  13. 13
    BG Says:

    #8 Steve) If your HDHP premiums are more expensive than your basic plan’s premiums — then I’d tend to favor your basic plan instead.

    The higher premiums, plus the higher deductibles likely make the tax savings from the HSA not worth it — but run your own numbers.

  14. 14
    BG Says:

    #10 Mase) you need to call your HR department to find out.

  15. 15
    harry Says:

    HI,

    My company’s HSA custodian is Fidelity and I want to transfer the money to another one. Are there any fees/taxes associated with this? Has anyone done this?

    Thanks!

  16. 16
    T S Says:

    Mase: My employer contributes $2,ooo at the end of the year. I keep that account open for those employer contributions and also my employee contributions, (and yes my contributions are before SS and medicare taxes). And…

    Harry: I also did a partial custodial to custodial transfer. This transfer is quite similar to those that can be done with IRA’s. There are no taxes owed because it is a transfer and I never take the money, it is a transfer between the custodians. Fidelity may have a partial transfer out fee. And almost any new account will have its own set up fees as well. The money can sometimes be requested thru bank wire (which almost alway incurs more fees) but usually they can just mail a check from your current custodian to the next one without fees. I would allow 4-6 weeks in total from 1)setting up the new account to 2)submitting a transfer request with your current custodian, and then 3) for the transfer to actually get to your new custodian. I called each custodian ahead of time and had them direct me and answer these type of questions.

  17. 17
    Nick Says:

    Has anyone used http://www.hsaadministrators.info ? They claim to allow HSA investments into 22 different Vanguard funds (including some admiral funds). They list a $20 account setup fee and a $39 annual administration fee.

    I’m curious to hear from anyone who’s used this?

    Thanks!

  18. 18
    Jan Says:

    If you are using your HSA as an investment, BE AWARE of new rules effective January 1, 2011 that remove the tax free withdrawals for OTC items without a prescription and the provision that funds can be used for ANY purpose after age 65. Consult your tax advisor. Read more here:

    http://www.irs.gov/newsroom/ar.....08,00.html

  19. 19
    Alex Says:

    As of 10/31/10, the IRS page in the previous comment doesn’t say anything about using funds for any purpose after age 65.

  20. 20
    Mase Says:

    as of right now, you are taxes on non-qualified medical expenses distributions, whether made before or after you are 65. However, after you are 65, such non-qualified distribution is not subject to the additional 10% tax. The relevant Q&A states:

    Additional tax. There is an additional 10% tax on the part of your distributions not used for qualified medical expenses. Figure the tax on Form 8889 and file it with your Form 1040 or Form 1040NR. Report the additional tax on Form 1040, line 60, or Form 1040NR, line 57, and enter “HSA” and the amount on the dotted line next to that line.

    Exceptions. There is no additional tax on distributions made after the date you are disabled, reach age 65, or die.

    See
    http://www.irs.gov/publication.....#038;lt;/b.

  21. 21
    Reddy Says:

    I have HSA ballance $4500/- left out with my Old employer , HSA Bank ACS Mellon

    Now I am with new Empoloyer , Opened New HSA account with chase. and employer sending money to new Account .

    I have 2 options

    1. Roll Over ACS to Chase
    2. Imvest Ballance in Other Options?

    What type of investment options i have on HSA ballance funds .

  22. 22
    Joseph M. Jarvis Says:

    You write: “The only possible gotcha with this strategy would be if there are restrictions on, or fees associated with, transfers to a new custodian.”

    I’m not a tax attorney, but as I understand the tax code, individuals get only one rollover per 365-day period, and that’s all accounts combined, not per account. See 26 U.S.C. § 223(d)(5)(B).

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