Q.
Should I use my HSA for out of pocket health care expenses or use it as a Stealth IRA?
A.
I've written before about the wonderful benefits of a Health Savings Account (HSA.) If used for health care expenses, it can be a triple tax-free account. This makes it better than a traditional IRA, a Roth IRA, and a 529 account. You get an up-front tax deduction just like with a traditional IRA, it grows without the drag of taxes on dividends and capital gains that you see in a taxable account, and if spent on health care, the money isn't taxed when you pull it out of the account either! As an added bonus, when you past age 59 1/2, it can be used like a traditional IRA to pay living expenses or buy a new car. Of course, if you don't spend it on health care costs, you do have to pay taxes on the withdrawals at your ordinary tax rate. But there's a wonderful catch.
The Catch
The IRS doesn't dictate WHEN you spend the money on health care. Just because you spent money on health care in 2012 doesn't mean you have to pull the money out of the HSA in 2012. You can pull it out in 2047 for all they care. All you have to do is keep the receipts. So you just need to get a new folder for your filing cabinet, mark it health care receipts, and keep track of every dime you spend on health care over the next few decades. Then, you pull the money and spend it on an around the world cruise. As long as the cruise costs less than the amount of money you've spent on approved health care expenses out of pocket for the last few decades, the withdrawal is tax and penalty free.
Should You Do It?
With that background, we can move on to the question. Should you actually do this? Obviously if you spend less on health care than you contribute to the account that year currently limited to ($3125 single, $6250 married for 2012) you should leave the difference in the account to keep growing. But why not pay for all your health care costs out of current earnings, and leave the money in the HSA for decades? Some people have made arguments against doing this, but I think they're pretty weak. We'll start with the best arguments, and work out way down to the weaker ones.
7 Faulty Arguments To Spend HSA Money Now
1) I don't have the money.
It's obviously better to use your HSA to pay your health care costs than to take out a credit card loan at 20% to do so. It might even be better than using your emergency fund. But I don't buy this argument for several reasons. First, if you have the money to max out an HSA each year, you probably make pretty good money. Paying a few hundred or even a few thousand for current health care expenses shouldn't be a huge burden. You can get a high deductible health plan with a deductible as low as $2400 a year (family), that's just $200 bucks a month, on the order of 1% of a typical physician income. Second, even if you used your emergency fund, if another emergency came up you could always just tap the HSA then. It's not like the opportunity to use the money ever goes away. In fact, the more you spend on health care out of pocket, the more of your HSA becomes a tax-free, tax-protected, and possibly asset-protected emergency fund. Even a brief credit card loan may be worth keeping that money in the account. If nothing else, you can pull the money out and pay off the loan at any time. With all the 0% for 15 month offers I get in the mail, it would be hard for me to justify touching the HSA.
2) I am in a higher tax bracket now than in retirement.
You get the tax deduction when you contribute to the HSA, not when you withdraw from it. It doesn't cost you more in taxes to spend taxable money than it does to spend tax-free money, so why not spend taxable money? Even if you end up using the HSA as an IRA, you'll almost surely have a lower effective tax rate in retirement than your marginal rate now.
3) I might die with a folder full of receipts.
I don't see any reason your estate can't do the same thing you would do if you were still alive, although I admit it would be a bit of a hassle, and perhaps not even allowed if it wasn't in the same year you died. For this reason you might want to tap the HSA funds already “spent” on health care expenses relatively early in retirement.
4) I'm not maxing out your tax-protected retirement accounts anyway.
Since this account is triple tax-free, it's better than all your other retirement accounts. Would you withdraw contributions to a Roth IRA to pay for health care expenses? Not if you could help it. It's the same thing we're talking about here. You should max out your HSA even if you're not maxing out your 401K, since it is more valuable, and it likely has more investing options and lower expenses anyway.
5) My HSA only pays me 1-2%! I might as well spend it.
Since you're not going to withdraw this HSA money any time soon, you ought to be investing it as aggressively as the rest of your retirement portfolio. I only keep enough cash in mine to minimize fees. The rest of the account is 100% stocks.
6) I may NEVER spend this money on health care.
If you are very healthy, or have access to very comprehensive health insurance such as that provided to military retirees, it's possible you'll get to the end of your life and have not spent as much on health care as your HSA contains. While I'd say that's a wonderful thing, the HSA is still no different than a traditional IRA. You just have to pay taxes at your current tax rate upon withdrawal. Even if you die, the HSA becomes your spouse's HSA. If you have no spouse (or make someone besides the spouse the beneficiary), the beneficiary inherits a fully taxable lump sum. Trust me, they'll still be happy. If you leave it to your estate, it will be subject to income taxes for your last year of life (and possibly estate taxes if you have enough money.)
7) The IRS might change the rules. I want to get my tax break now.
8) My HSA has lots of expenses and poor investment choices.It's always hard to combat these types of arguments. These are the same people who tell you to use a traditional IRA instead of a Roth one- get your tax break while you still can! But I think you need to not only consider the consequences of these types of tax law changes, but also their probability. Changes like these are usually grandfathered in. Sure, the US Government may implode, but are you really going to plan your finances around that possibility?
Move your HSA elsewhere. Although there is some tax benefit (you save payroll taxes on it) for an employee to have their employer contribute money directly to their HSA, you can usually roll it out within a year to your preferred HSA. For an independent contractor or partner, I see no reason not to use the best HSA you can find.
Try as I might, I can't think of any reason to use my HSA money any time soon. But I am stuffing every health care receipt into a folder I plan to keep for decades. It might even be worth archiving them electronically as well.
In number 6 you reference people that may have comprehensive health care or are in the military, but according to your September post about choosing a HSA you said that you can only get an HSA with a hi deductible health plan. I currently max out my TSP and Roth IRA so I would love to have another tax advantaged account, but can it be an HSA or not?
my wife is the one that has the HSA account (teacher) and the school will only direct the money into a bank account that has no investment option and only earns 0.1%
Do I transfer part of it into another HSA bank when i reach a certain threshold of money?
Right now i’m just spending it on health care, but i only spend a small fraction of the money.
I do tend to agree that taking money out of your HSA is not a great idea, but I do think there are reasons. For me, I plan to pay for my 3 kids braces with it, which will run about $10,000-15,000 if not more when they finally get old enough in a few years. I do have access to a limited FSA account for dental expenses, but it maxes out at 2500 per year with obamacare. I also plan to use it for large healthcare expenses.
Currently, I save ~30% of my income for retirement in other tax advantaged accounts. So, it would be great to keep money in the HSA, but I just can not justify saving the HSA. The HSA might be a better tax savings than my other accounts, but at some point I think I need to draw the line and say I am saving too much at the expense of living now.
Keith- No, if you’re covered under Tricare you can’t contribute to an HSA. But if you had one for a few years, then joined the military, you could keep the one you had.
Z- That’s exactly what you do. Usually you can do it at least once a year.
Alan- Good points. You only need so much.
Sometimes i think this is a little putting the cart before the horse. Only certain health care plans are HSA compatible. It needs to make sense to have one of those plans (usually high deductible) vs a normal deductible plan in order to make any of this worth doing. If you project a significant amount of health care utilization during the year then you might not want to go the HSA route.
Absolutely. If you have the choice between a low-deductible and a high-deductible plan, you need to decide that first. Although you can get a deductible as low as $1200/2400 (single/married) and still have an HDHP and an HSA.
I am interested in the HSA option next year but I am not sure its such a great deal for me.
I can get a mid level plan where I get $2000 from my employer with a $2000 deductible. This is basically a wash, but all money is lost end of year. I pay a 10% copay on all expenses after the deductible in my employers network or 20% in the insurance companies network.
The HSA option only gets me $1350 from my employer but the deductible is $4000. After the deductible it pays the same as the plan above. I like the idea that I can keep the money but the deductible is much higher and I have a wife, a child, and likely another on the way.
Here is my dilemma. The plans cost me the exact same per paycheck. If the HSA were saving me money per paycheck or if I was a single guy I would be all over it but as a family man I am having a hard time seeing the benefit to the HSA right now. (I still have enough debt that using the HSA to stash money tax free is not a real benefit as I dont’ have much more to put in there).
Do you have any references regarding accumulating expenses and saving receipts now, only to pull the money out later (in 2047, as you suggest)? Even if this is possible now, I could easily see the IRS ruling against this issue later.
WCI and others,
my wife has a High deductible plan with HSA. I have a separate health insurance plan (PPO) with different employer and have access to HRA ( Health reimbursement account-employer funded).
If my wife incurs healthcare expenses, I know I am not supposed to use my HRA to pay her expenses , but is there anyway for the IRS to enforce this ? Will we incur any penalty for doing this ?
Beau- It doesn’t sound like the HDHP/HSA is a good deal for you right now. That’s okay. It might change in the future, or it might not. If you couldn’t max it out anyway and leave it alone, it doesn’t matter much.
Sean- I don’t see why the HRA would reimburse medical expenses on her if she isn’t covered under your plan. Is she double covered or not? If she is double covered, I don’t think she can have an HSA. If she isn’t double covered, remember her HSA limit is the lower “single” limit of $3100 per year. With the HRA I used to have, I had to turn in receipts to get reimbursed. If the receipt had my wife’s name on it and she wasn’t covered, I don’t think they would have paid for it.
Steve- Yes, I suppose there’s always the risk that the IRS could change things. But there’s usually some warning on stuff like that and you usually get grandfathered in. So if in 10 years they change the rules, you could just pull out what you’ve spend on health care in the last 10 years then.
IRS Pub 969 page 9 section “Recordkeeping” on the bottom left reads:
Recordkeeping. You must keep records sufficient to show that:
The distributions were exclusively to pay or reimburse qualified medical expenses,
The qualified medical expenses had not been previously
paid or reimbursed from another source, and
The medical expenses had not been taken as an itemized deduction in any year.
Do not send these records with your tax return. Keep them with your tax records.
That seems to imply that the expenses don’t have to be from this year. The next section says you report these distributions on Form 8889.
http://www.irs.gov/pub/irs-pdf/f8889.pdf
In the instructions for line 15
http://www.irs.gov/pub/irs-pdf/i8889.pdf
the only requirements for distributions are that they were spent on a qualified medical expense and that the expense occurred after you became qualified for an HDHP. Granted, they don’t come right out and explain how you can reimburse yourself years later, but there doesn’t seem to be any rule saying you can’t. I suppose you could argue this isn’t the intent of Congress or the IRS, but neither is doing Backdoor Roth IRAs. There’s a reason they’re called loopholes.
Worst case scenario is you end up with another IRA. Is that so bad? If you’re really worried about it, use the HSA to pay expenses now and just keep the extra for later.
Either way, I’d keep all your health care receipts.
WCI
Following up on the earlier question about my wife having a HSA and me having a PPO with employer funded HRA.
My wife is going to be single covered thru her High deductible plan w/ HSA.
My HRA allows medical expenses of spouse to be reimbursed even if the spouse is not covered under my insurance. It is akin to a husband’s FSA paying for the wife’s expenses, even if the wife is not covered under the husbands health plan. This is know for sure because of current and past reimbursements.
I know that if one spouse has high deductible plan, the other spouse even if not covered by the same plan, cannot have a FSA. Since FSA contributions contributions show up on W-2. This would disqualify all HSA contributions
But what about HRA money, since mine is employer funded, once I submit my wife’s reciepts, I know my HRA will reimburse me. My question then is ,are there specific rules against this ? if yes, how can it enforced since employer HRA contribution does not show up W-2
Sean-
You lost me a little bit in the FSA comparison. If your HRA allows reimbursement of your wife’s medical expenses even if she isn’t covered, that’s cool. The only question I think we need to answer is “does that fact disqualify her from making HSA contributions?” I suppose if it does, then you could consider doing it illegally anyway. Kind of like reporting tips I suppose.
Let’s see if we can find that answer:
From Pub 969, page 4 on the upper right side says an employee covered by an HDHP and an HRA generally cannot make HSA contributions. That would seem to fit your wife I would say, even thought the HRA is from your employer. The only exception seems to be if it is a limited use HRA (just pays dental and vision for example), but I don’t think you can just use the HRA for dental (instead of all kinds of stuff) and then claim it as limited use. My understanding is that your spouse is NOT eligible to contribute to an HSA because of your HRA. I don’t know how it could be enforced.
Are you sure this is the best way to pay for your health care? Could you get one of your employers to pay you more in lieu of insurance and put you on your spouse’s plan? It would seem more efficient for you both to be on the same plan, but there’s a lot of screwy situations out there.
I am single and independent contractor. I want to know if I can contribute pre-tax dollars to an HSA and then use personal funds to pay for my HDHP and then claim the deduction on my federal tax return?
Sam-
I’m a little unclear what you’re asking. Yes you can contribute pre-tax dollars to an HSA (assuming you have a HDHP.) You may also use personal funds to pay for your HDHP. You may deduct those premiums from your taxable income (1040 line 29), but you can’t pay for them with your HSA. Health care that you purchase may be paid for using HSA dollars this year. You may also pay for it out of pocket, keep the receipts, and pull the money out of the HSA some time later, tax-free. Or, you could pay for your health care out of pocket and deduct the cost on Schedule A (but there is a floor, 7.5% of your taxable income I believe.) You cannot deduct the cost on Schedule A AND use HSA funds to pay for it.
I hope I answered your question in there somewhere.
I’ve liked many parts of your site but a couple of points here really don’t seem to hold water. Most egregiously #2. It certainly costs more to bear an expense post-tax than pre-tax. Why would anybody spend $4 post-tax (after paying $2 in income taxes, as an example) over paying $4 pre-tax, then having a lower tax base (with, say, $1.50 in income taxes)? The argument only holds up if the person maxed out their tax-deferred investments (shooting down the point in #4), and can afford medical expenses post-tax, saying the pre-tax investment incentives in the HSA outweigh the post-tax investments that would otherwise be made (if you paid medical expenses from your HSA). But if the tax-deferred investments *weren’t* maximized, why would anybody spend money post-tax that could have been spent pre-tax? Spending it post-tax meant you needlessly had a higher tax base.
You say: “Since this account is triple tax-free, it’s better than all your other retirement accounts. Would you withdraw contributions to a Roth IRA to pay for health care expenses? Not if you could help it.” It looks like too many people get hung up on “triple tax-free”. That’s only a ‘triple’ if the money is spent on health care. If it’s not spent on health care, it’s only ‘double tax-free’. The analogy to the Roth IRA doesn’t work, because you don’t withdraw from the Roth IRA due to the penalties involved. But there are no penalties on medical expenditures from the HSA…
I can see the logic if tax-deferred vehicles were maximized, but that logic only works if the pre-tax HSA investments made accumulate to higher than any post-tax investments made with the money that would otherwise have been spent from the HSA. Likely but not a guarantee (can’t buy real estate from the HSA). And you still need to keep all receipts til kingdom come and count on the IRS not changing the rules to require qualifying medical expenditures be made the same year as the withdrawal. That’s a really fine line to be playing with $3k-$6k a year in comparison to $50k or more per year with other tax-deferred vehicles (for self-employed, in this instance). I’m not trashing the HSA, but there does not seem to be clear cut logic for making it one’s primary pre-tax investment vehicle…
I think you’d like this post:
https://www.whitecoatinvestor.com/the-best-ways-to-use-an-hsa/
I agree that spending your HSA on current health care needs can be a great use of the money. Not quite as good as spending it on future health care needs decades away, especially if you’re still in a very high tax bracket, but still good.
Thank you very much for the reply. I did actually read that post and the HCP link within it. I completely agree (I think it’s true empirically) that if the HSA is maxed out and used 100% for health care needs in old age, and all other tax-deferred retirement options are maximized, that’s the absolute best use for it. But that still shoots down #4 on this post. And per #4 in the HCP link, it’s not a good financial move if you don’t use 100% of it. So where is the budgetary line drawn for what those medical expenses will be in old age (including defining when that ‘old age’ begins)? Will it certainly meet or exceed the maximum you can invest in your HSA? We’re getting into probabilities here that aren’t definite (which is why financial choices will frequently become more art than science, depending on the philosophical choices of the investor), and the line gets fuzzier for whether it’s best to pay current expenses post-tax vs. pre-tax. My disagreement (if you want to call it that) is these qualifiers got left out of the discussion. IMHO, it makes the conclusion presented less clear-cut (though again, I’m not saying it’s wholly illogical). And as may be able to be inferred by my comments on a 3+ year old post, I got into an argument with someone recently who was taking these conclusions word-for-word without fully digesting all the qualifiers involved… 🙂
One of my bigger problems is how #5 is presented on the HCP link, which has been quoted and/or echoed on this site. It talks about paying medical expenses for a baby post-tax now, and how if you keep those medical expense receipts, you can buy a boat with tax-free dollars 20 years or so later. That can be a little misleading. You paid taxes on the money spent for current medical expenses (the baby, etc.). The only thing you wouldn’t pay taxes on are the capital gains (over 20 or so years) from the money you kept in the HSA instead of using for current medical expenses. Now, from $6k per year, making 10% per year on the investment, over 20 years, would that add up to the price of a boat? Very probably, but you have to remember that you’re still taxed that one time on the net capital gains you pull out; you’re only not taxed on what you have receipts for (but you paid taxes on those earlier, because you bore the medical expenses post-tax). So it can make sense, but a lot has to be done for it to make sense (more than has been presented in these various posts, IMHO). And also, are there other tax-deferred options that could be utilized to achieve your investment goals (including a boat in 20 years), while still paying current medical expenses with pre-tax money? That’s more the point. Why is someone letting money for medical expenses be taxed? If there is no other tax-deferred option for their investment goals, it makes sense (assuming no post-tax investment could do as well as pre-tax; yes, plenty of flexibility with HSA investing, but it’s not a completely fluid investment vehicle), as long as all qualifiers apply (maximizing the account for many years, making good [10% or what have you annual returns] investments with it, and spending it all before dying). Guess I’m just pushing for those qualifiers to be in the discussion, or see if there’s something I’m missing…
Thank you again
No, I don’t think you’re missing anything. It is complicated and hard to predict the future and clearly you would have been better off spending money on health care pre-tax during your peak earnings years than leaving HSA money to your heirs.
Hi,
I currently have non-HSA eligible low deductible individual plans for my son and wife through Blue Cross Blue Shield of Mississippi. My individual plan is through my employer as part of my benefit package, and is also low deductible.
My question is:
In order to be eligible for an HSA do I need to convert each individual account to an HSA eligible one? or Just mine and my wife’s? or my two sons as well? Blue Cross Blue Shield does not offer “family” plans.
One person on a HDHP allows you to make a single contribution, two people lets you do a family contribution. But choose your health insurance plan first. Don’t choose a health insurance plan that doesn’t work well for you just to get an HSA.
Hey WCI,
Are there any good calculators/resources out there to determine if you will come out ahead using a HDHP vs a traditional one? Or how to compare my HDHP vs my wife’s?
Not that I know of. I would just look at the policies, think about what you typically spend, and make a decision.
Personally, I have our HSA accounts with HSA administrators and what I noticed is, the investment options are not attractive at all! (Vanguard admirals)
In fact i think the lack of growth actually takes the triple tax benefit away since it acts like an extremely weak Roth IRA.
What I have been doing is I have been withdrawing and matching our medical expenses which has been unfortunately a lot lately and put the money in our SEP IRA or directly investing it in a Non retirement account in Vanguard for a %10 growth. I feel that paying taxes on growth is better than not having any growth.
I am open to learn about any reasons why this might not be the best idea.
Thank you
Paris
What are you buying in your SEP-IRA that you can’t get in your HSA Administrators HSA?