Question: For 2012, I'm switching to a high-deductible health plan and will enroll in the associated health savings account. What investment strategy do you recommend? Cash, bonds or total market? Ken, Portland, OR
Many plans allow participants to invest in a variety of securities, including certificates of deposit, stocks, bonds and mutual funds. But the money is typically stashed in low-risk bank-type accounts. It's the right move because you want the money there when it's time to pay the medical bills.
Here's a brief definition of a health savings account insurance plan for those who have heard the term but aren't quite sure what it means. It's a high-deductible (catastrophic) insurance plan. For 2012, the annual deductible can't be less than $1,200 for individuals and $2,400 for a family. The required out-of-pocket maximums are $6,050 for individuals and $12,100 for families.
The money that goes into the health savings account attached to the plan is pretax dollars. The maximum contribution for 2012 is $3,100 for an individual and $6,250 for a family The IRS published the 2012 rules here.
Employers typically kick money into the account if it's an employer-sponsored plan. You pay for qualified medical expenses tax-free from the account. Any unused money in the health savings account rolls over into the next year.
So, if you get lucky and your medical bills are minimal, your account will swell in value over time. At some point, you could consider keeping half to two-thirds of the money in the bank for short-term bills and invest the rest. No matter what, I would opt for high-quality, blue-chip-type investments when you're comfortable becoming a bit more aggressive with some of the money. An advantage of this approach is that the money will compound and, assuming you don't use it all, will be there for you to make tax-free withdrawals for medical expenses in retirement.