With new technologies come new terminology like “YOLO,” “swipe right,” and “life hack.” As consumers, we hope to catch on quickly so that we can understand and communicate across generations. However, when discussing finances or financial topics through websites, books, magazines, and television shows, there are many decades-old terms that haven’t been fully explained in the context of everyday life. This monthly series will explore some of these terms so that you can include them in your various life hacks.
Health Savings Account (HSA), FICO, and Stocks
Our first term is Health Savings Account (HSA). An HSA is an account that—if used properly—has the ability to reduce your taxable income by using a pre-tax deduction to pay for health insurance expenses. HSAs can help manage health insurance costs but have restrictions put on them by the Internal Revenue Service (IRS) that can limit how and where it is used, as well as how much can be added to the account.
Another term you often hear on commercials or when looking to buy a home or refinance is your FICO® score. FICO® is a scoring system based on your credit rating that affects your ability to obtain loans and borrow money. It was developed in the 1950s by the Fair Isaac Corporation, a now publicly traded company. FICO® scores are used across the globe and have become an integral part of the banking system and the housing markets.
Our last word for the month is stocks. Stocks have become part of our everyday lives as websites, local news, and national TV broadcasts give us a daily look at how the Dow Jones Industrial Average (Dow Jones) or Standard & Poors 500 (S&P) performed and how specific stocks like Apple and Amazon move up and down. Most people have exposure to stock either by directly owning shares or through an Exchanged Traded Fund (ETF) or mutual fund within retirement plans at work.
Why these Terms are Important for You
While you may have heard of these phrases and words, you may not have seen them used in situations that affect you directly. HSAs fall into this category. An account where you can put away money to be used for healthcare expenses seems simple enough; however, the IRS has put parameters in place to allow for the maximum use of the account without being able to usurp federal tax laws. Such accounts were set up to provide tax deductions if you put money aside that can only be used for qualified medical expenses. Any time you are using an account or process to reduce taxable income, you should always contact a tax preparer ahead of time.
Dollars within HSAs can either be used to pay qualified medical expenses directly—usually via a debit card—or you can reimburse yourself for expenses already incurred. For 2019, the IRS has set the annual contribution limit and income deductibility to $3,500 for an individual and $7,000 for a family. While these accounts cannot be used to pay for many over-the-counter medications like Advil or Pepto-Bismol, they can be used for office visits, medical procedures, and prescription medication. Unlike a Flexible Savings Account (FSA), money leftover in HSAs at the end of the year can be carried over to the next year and beyond to cover future medical expenses. Different rules apply at death based on who the beneficiary of the account is.
But be forewarned that the the adage “there’s no such thing as a free lunch” applies here. While the IRS allows you to take a tax deduction to put money into HSAs, there are rules. Qualifying for HSAs includes the meeting all three of the following criteria:
- You must be covered under a high-deductible health plan (HDHP)
- You must not be enrolled in Medicare
- You can’t be claimed as a dependent on someone else’s tax return
Before opening this type of account, you may want to work with your financial advisor and accountant to help determine if it is appropriate for you. The conversation should include whether you qualify according to the last month rule1 and the definitions of a high deductible plan. Your employer is eligible to make contributions to your account, but in this case, they get the tax deduction. If the account is not used for qualified medical expenses, the distributions can be added to your income and be assessed with a 20% tax. HSAs can be very useful to earmark money specifically for medical expenses that you might have paid anyway, but you’ll get a tax deduction along the way. This, of course, hinges on whether you qualify or not.
You’re designated a FICO® a score based on how much credit or debt you have outstanding, how successful you have been at paying off loans, types of credit accounts you have (e.g. car loans or credit cards) and how long you have had credit accounts open. Mortgage lenders, banks, and credit card companies use this score (usually between 300-850) to determine whether you qualify for a loan or access to credit and how much a lender can offer you.
One of the most common questions around FICO® is how to find out your credit score. Generally, when you apply for a loan at a bank, mortgage company, or auto dealership, the lender looks up your credit score and can provide you with that information. Some credit card companies are now offering to provide you a score for free depending on the card company and type of card. For a fee, you can contact credit monitoring services that offer access to your score. Always remember to understand the source of the website you are accessing because you will be asked for your social security number. If you are unsure of the website or company, you can contact the Consumer Financial Protection Bureau.
Credit scores can vary because they are potentially based on different sources, different time frames and scoring models; e.g., besides FICO®, VantageScore and other custom models may be used depending on the lender). If you want to get an idea of what your credit looks like without paying for a score, you can access the three major credit reporting companies at https://www.AnnualCreditReport.com, where you are provided with a free credit report from each company once a year. For a fee, these companies also offer additional credit monitoring and FICO® scores for a fee.
Getting a Less than Desirable Score
Once you’ve found your FICO®, you may not be entirely happy with the number, but there are different strategies to increase your score. Improving your score could allow you to get a better interest rate on a loan or a higher credit limit on a credit card. Keep in mind lenders are loaning money with the intention of you paying it back to them at the same time every month. Therefore, late payments do not look good to lenders. Setting up an auto-pay for the same monthly payment can help show the lender you are reliable and consistent if you are not able to manually make this payment at the same time every month. Additionally, paying down existing debt can improve your score, so if you have an outstanding balance on a credit card and can pay it off, do it. This will save on interest as well as boost your credit score. How long you’ve had credit is an important factor. If you use one credit card and are considering cancelling it to either use another one or just a debit card, you may want to keep it open—after taking the card’s fees into consideration—because keeping a card open will show a longer history on your credit report. If you cancel an older card, lenders may only look at the newer accounts that you have open. Sometimes we may not have full control over our credit score because there may only be a credit card and no car loan or mortgage, eventuating in a minimal credit mix. Or, perhaps, you’ve recently taken out a loan. Regardless of these extenuating factors, continuing to pay bills on time and reducing—or eliminating—debt are effective ways to continually improve your credit score.
Many people may be intimidated with even a conversation around stocks, but the market can be more approachable than you realize. One simple way to conceive of a stock is that it represents a chunk of ownership in a company. If I own one share of Netflix, for example, I am an owner of Netflix, Inc. That said, my ownership is 0.0000002% of the company, so while I you may have a vote, your voice is relatively small, and the CEO of Netflix, Reed Hastings, probably won’t listen to you if you ask to change the Netflix logo from red to forest green. If things go well and the stock price goes up by 1%, the value of your ownership goes up by 1%. The same is true when the stock price goes down. Your ownership percentage can also change based on stock options and buybacks, but we will discuss these concepts in future posts.
Buying stocks should be a well-informed decision. If you believe in the success of a company, you may want to be a part of the ownership group. Stock ownership is an excellent way to participate in a company you believe in. (Either that, or you can always buy a company like Netflix outright, provided you have more than $120 billion at your disposal.) Picking the right stocks to own depends on many factors and should be discussed with your financial advisor. Some companies are riskier than others and may require a bigger discount to their intrinsic value than others. How risk is defined varies based on the investor, or owner of the stock, as well as the industry, rate-of-return goals, and time frame of how long you have to invest. Warren Buffett, one of the greatest business owners and investors of the last 100 years, has said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”2 There are many theories, models, and ratios that analysts and investors use to determine both what defines a “wonderful company” and what is a “fair price.” Many people have opinions about whether the McDonald’s or Portillo’s has the best french fries. The same is true for stocks. For example, many successful investors have disagreements as to whether you should buy General Motors or Ford if you want exposure to a car company.
Owning one share of a company’s stock allows you to be a hands-off owner when it comes to day-to-day tasks such as deciding how much printer toner to buy or whether to provide parking spots for employees. Some companies return some of their profits to their owners, also known as shareholders, in the form of dividends. While it can be nice to wake up one morning and see a few extra dollars in your account, you may need to be aware of some of the responsibilities of being a shareholder. For example, you may be responsible for paying taxes on your dividends depending on the type of account. Owning stock in a foreign company like Royal Dutch Shell or Alibaba may have additional tax considerations. When it comes time to sell your share in the company, you may be responsible for paying taxes on the difference between the current value and what you paid for it. Unfortunately, some companies don’t make for the long-term such as Blockbuster and Lehman Brothers. Your accountant and financial planner can help you navigate through the different types of accounts and contexts to help determine how best to own stock—whether it be through individual share purchases, a mutual fund that owns shares of companies, or via an ETF that can also own shares of companies.