November 18, 2018
Every week, Simply Money’s Nathan Bachrach, Ed Finke and Amy Wagner are answering your financial questions in The Cincinnati Enquirer. If you, a friend, or someone in your family has a money issue or problem, please feel free to send those questions to email@example.com
Kyle in Independence: I’m going through the open enrollment period at work for my healthcare. What’s the better type of account in your opinion, an HSA or an FSA?
Answer: This is the battle of the healthcare heavyweights! While both types of accounts offer tax-advantaged ways to save on current and future healthcare costs, in our view, one definitely comes out on top.
A Flexible Spending Account (FSA) comes with no eligibility requirements. It allows you to contribute pre-tax money which then comes out tax-free if used to pay for qualified healthcare and medical expenses throughout the calendar year. But this means you need to carefully consider how much you think you’ll spend on prescriptions, co-pays, and other health expenses in 2019. Because the big downside of an FSA is its “use it or lose it” feature – if you don’t spend all the money you’ve contributed by the end of the year, your money is gone (in most cases).
If made through a payroll deduction, contributions to a Health Savings Account (HSA) are made with pre-tax money. Like an FSA, withdrawals for qualified healthcare and medical expenses come out tax-free. Unlike an FSA, money in an HSA rolls over from year-to-year, and you can take the account with you if you switch jobs. But there’s a big catch. To use an HSA, you must have a qualified high-deductible healthcare plan. The downside here is higher out-of-pocket expenses, so we suggest accounting for that in your emergency fund.
But there’s one big benefit to using an HSA that an FSA can’t come close to competing with: the long-term planning advantage. Instead of using an HSA to pay for medical expenses that pop up now, you can treat it like any other retirement account and let it grow. After all, you know you’ll have healthcare bills in retirement – so why not let the power of tax-free growth work in your favor? Plus, once you hit age 65, you can use money in your HSA to pay for non-medical expenses and you’ll only have to pay ordinary income tax on those withdrawals (no penalty). This feature basically turns an HSA into a de facto 401(k) in retirement, if needed.
The Simply Money Point is that choosing between an FSA and an HSA depends on your family’s particular situation. But if you’re looking for a tax-savvy way to help pay for healthcare costs in retirement, an HSA is a great option.
Jon from Hyde Park: Can you explain the pros and cons of bond laddering? I’m trying to decide if it makes sense for me.
Answer: First, let’s make sure we’re on the same page about the definition of a ‘bond ladder.’ By owning individual bonds with different maturity dates, an investor creates a staggered (or, laddered) way to protect their money from the risks that come with fixed-income investments, as well as a way to produce a steady income stream over a set period of time.
The benefits of using a bond ladder are two-fold: you’re taking advantage of rising interest rates by investing maturing bonds in new bonds that pay more income; plus, if you hold the bond to maturity, you won’t need to worry about daily price changes (simply, you know what you’ll be getting).
However, there are plenty of downsides to using a bond ladder as well: if interest rates fall, you’ll be earning less income than you otherwise would have had you just purchased a longer-term bond; if you need cash quickly you would be selling the bond before maturity, forcing you to potentially sell it for less than you think it’s worth; since you’re investing in individual bonds, you’re exposed to the risk of losing your principal if a company that’s issuing the bond goes under; and to truly be diversified you need to own bonds from a lot of different issuers, which means doing a significant amount of research and potentially paying a lot of transaction costs.
The Simply Money Point is that a bond ladder can make sense if interest rates rise, but understand that creating and maintaining it can be time consuming and expensive. On the flip side, if interest rates fall, you’ll be in worse financial shape than you would have been if you hadn’t done the ladder.
Responses are for informational purposes only and individuals should consider whether any general recommendation in these responses are suitable for their particular circumstances based on investment objectives, financial situation and needs. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing, including a tax advisor and/or attorney. Nathan Bachrach and Ed Finke and their team offer financial planning services through Simply Money Advisors, a SEC Registered Investment Advisor. Call (513) 469-7500 or email firstname.lastname@example.org.