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.