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When the time comes to cash out HSA

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  • When the time comes to cash out HSA

    I've learned the strategy of using the HSA as an investment vehicle from WCI. Wanted to double check with the forum on the cash-out strategy.  I'm in a high tax bracket now and paying for all medical expenses with cash, meanwhile each year max out the family HSA deposit, investing smart and letting it grow. If I'm planning on retiring early (maybe 55) is it wise to turn in all my receipts the last year I might be in the highest tax bracket or just let it ride? Thank you.

  • #2
    What do you mean by "turn in all your receipts"? You shouldn't have to turn in any receipts, just save for documentation in the event you are audited. Use of your HSA should be driven by cash flow needs. If you can afford to fund your medical expenses after RE, then you should continue to let your investments grow. Use it for a large unexpected expense when you are older and in need of more health care, for example.

    otoh, you need to have a plan for using this account. If you have a big surgery coming up soon and your HSA is the only place you can turn to for $2,500 OOP expenses, liquidate that much immediately. Any needs within the next 5 years should be kept liquid. However, if you're planning on retiring that early, you'll probably (hopefully) have enough saved that you won't have to tap your HSA. Spend from liquid reserves whenever possible, letting the HSA grow.

    Tax planning will also help when you get to the point of using your 401k/IRA, but that's an issue of liquidity and taxes more than when to spend down your HSA v. taking $ out of your Roth or TIRA.
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    • #3
      I'm saving receipts just in case everything else goes off the rails, but I expect to use the HSA for health expenses between retirement and death....


      • #4
        Here are some additional general guidelines when it comes HSA money:

        • Always take tax-free HSA distributions of unreimbursed qualified medical expenses, before any Roth distributions. It will be reducing the amount of tax-free distributions that come with "strings" (receipts)*.

        • If and when there are only non-spouse beneficiaries. an RMD-like draw-down over the individual's life expectancy starting at 65 - 70 should be considered**.

        *The use of tax-free distributions (tax-loss carryovers, Roth and HSA accounts) can be an effective tool for managing your taxable income in withdrawal phase. E.g. I have far more tax-loss carryovers from 2000 - 2008 and 2008 -2009 than I can consume in my lifetime at $3K a year. Unlike step-up basis they are perishable at your death.

        I have been using a combination of tax-loss carryovers and tax-free distributions to generate (AGI/MAGI)-free income over the last five years to qualify for ACA premium and cost sharing subsidies. Along with Roth IRA tax-free distributions, they can be used for other cliffs. Most physicians will have the full 85% of their SS benefits taxed, but they will almost certainly be subject to IRMAA tiers and marginal tax brackets.

        **A spouse-beneficiary can assume full ownership of an inherited HSA and take HSA tax-free distributions of unreimbursed qualified medical expenses. However, with a non-spouse beneficiary, the entire HSA account is taxable in the year of death at their marginal ordinary income tax rates, except for unpaid bills of the decedent paid by the non-pouse beneficiary within one year.

        For this reason, if you only have non-spouse beneficiaries and your marginal tax rates are far lower than theirs. You might want to take non-qualified HSA distributions instead of other distributions of pre-tax retirement accounts. If you are >= age 65 and your remaining life expectancy is relatively short, depending on looming LTC expenses.


        • #5

          If I’m planning on retiring early (maybe 55) is it wise to turn in all my receipts the last year I might be in the highest tax bracket or just let it ride? Thank you.
          Click to expand...

          This question has me confused and makes me question your full understanding of HSA taxation. HSA contributions are essentially never taxed. You don't need to have a HDHP to withdraw from the HSA either. You just need to have qualified medical expenses. You could save receipts over time and incur new expenses later on. The withdrawals (assuming for qualified expenses, which is why we save receipts) are not taxed coming out, so your current marginal tax bracket has no effect on withdrawals. So, essentially, just let it ride until you're drawing down from retirement accounts (as spiritrider alluded to, usually tap the HSA before Roth accounts since neither are taxed).


          • #6
            One important thing to remember about HSA's versus other tax advantaged vehicles is that it is NOT advantageous to die with money in an HSA.  Unlike IRA's which currently can be stretched over the beneficiary's life expectancy and even with currently proposed legislation will still be stretchable over 10 years HSA's are taxable income to your beneficiaries 100% in the year of your death as ordinary income.  (Except for a surviving spouse, but that just delays the problem).

            That said, I have heard that retirement medical expenses should leave plenty of opportunities to tax-favorably utilize an HSA.


            • #7
              If you have maxed out your deferrals and Roth and your marginal investment is taxable it’s generally advisable to contribute to your HSA and cash flow the medical expenses.

              As for the draw down I would save all your receipts from past years but only to the extent that your HSA is enormous and you don’t expect IRMAA issues or do have a non-spousal beneficiary as Spiritrider mentioned (and were not in good health or retiring at normal/later age). If you retire at 55 and construct your draw down in a tax efficient manner in the first 10 years you may not have any IRMAA issues to worry about.