HSA treatment

[Donnie]

Rogue Dad, M.D. wrote:

 

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Responses below.

• You seem to assume any future tax changes would favor a taxable account.  While I’ve no idea what will happen, at the moment HSA’s seem to be gaining momentum to be more broadly available and able to be funded at a higher level, so they are unlikely to lose tax favored status anytime soon if they want people to use them.  My base assumption is that nothing changes in the tax code.  I think it is hard to know what changes will have been implemented when most of us are retired.  Most laws have inertia, so I err on sticking with what we have now.  I tend to agree with you that cap gains tax treatment seems more at risk than HSA withdrawal treatment though.

• But then even if we stick with current tax rates, I am not sure why we are using 33% — as WCI and others always point out, using current tax brackets, most of us should be in a LOWER bracket at retirement than we are now.  25-30% is the break even point depending on the assumed returns.

 

• You indicate that the whole receipt thing is fraught with issues — sure, saving any document for long periods is fraught with issues.  But a lot of people make it to death without losing a birth certificate or social security card.  My receipts are saved on Dropbox and then uploaded to ConnectYourCare.  It is NOT difficult to save receipts.  It takes no more effort to “save” the receipts then to actually use those same receipts to get the money out immediately.  I still have to electronically submit those receipts to CYC to access my money immediately, which means I’ve scanned it into my computer and put it on Dropbox and then uploaded it to CYC.  So uploading them and then NOT withdrawing isn’t really an effort issue, it’s more a matter of do I think Dropbox and CYC will fail on the same day without chance of recovery of any documents. Agreed.  It's not that hard to keep your receipts, but it is annoying and certainly there is risk of losing them.  I also think that IRS may take another look at receipt hoarding when folks withdraw very large amounts annually using old receipts.  Because HSAs are relatively new, I doubt anyone has tested this in full yet.

 

• I’m not sure how you chose $5k as the expenditure amount as a lot of people will have more than $5k/year in expenses in years they fund an HSA.  You’re specifically talking about high earners, and if you’re on a HDHP that qualifies for an HSA, then by definition your deductible must be at least $2,700 for a family, but in most cases is far higher.  A high earner (your scenario) who is self-employed using an HDHP/HSA may have a deductible of $8k or $10k or higher.  They can easily rack up that much in costs a year before hitting the deductible, so if paying out of pocket they could actually accrue as much in health care expenditures as they do in HSA contributions AND growth.  I hit my out of pocket max in both 2015 AND 2016, but I’m fortunate that my OOP max is only $5500 (less than my HSA contributions).  But once I am paying for braces, I’ll be racking up qualified expenditures that don’t count towards those numbers, so I could easily pay more out of pocket than I contribute to the HSA.  I just chose $5k as a dollar amount to illustrate the point.  Likely the correct thing to do is a mixture of savings receipts and withdrawing if your HSA is getting larger than you think will be necessary for future medical needs.  

 

• If you truly have only $5000 in expenditures to make tax free, AND you are somehow in a 33% bracket, then the math favors the taxable account (but I think those are assumptions that may not be accurate).  I’m too lazy to run the #’s and you seem like a #’s person, but what would the breakeven point in healthcare expenditures be to make the returns equal? Off hand it doesn’t seem like a big change — roughly $6k in expenditures (and thus tax free withdrawals) and the rest at your 33% ordinary income tax rates is about even. It is 25-30% depending on returns and tax drag on those returns.

Anyway, this all started in another thread on HSAs where the same debate was going on.  People were discussing saving receipts, letting the investments grow tax free, and making IRA-type withdrawals in retirement.  The thread had not been numbers based, which was annoying to me since the numbers can be figured out, and certainly they should be an input into financial decisions. 

When I ran the numbers, it surprised me that for typical tax brackets, returns, and tax drags used in sites like this, the HSA was worse if you are making IRA-type withdrawals than withdrawing from HSA and investing in taxable.  I had never seen that point written anywhere in any writings about HSAs. 

It's fine with me if you all agree with Spiritrider.  Hoarding receipts is not a bad decision, and you are not giving much up if you do end up having to make an IRA-type withdrawal.   I still think that understanding that it may not be the best move from a financial perspective is an interesting point that folks should understand as they hoard though. 

[G]

Well...I'm definitely not a math guy, but I'm saving my HSA for health expenses in retirement.  At least that's my plan.  I'm already part-time and dropping even more soon-- Given that my monthly income is going to be squeezed, I'm saving receipts in case I need emergency access to that cash earlier.  However, why not wait til retired and use it for a new hearing aid or that hospital co-pay?

Donnie, you're right that it is incredible to think of people retiring if they need $0.5-1M saved up for medical expenses.  It's one of the elephants in the room of American healthcare.  Folks think it is ridiculous that healthcare costs 20% of GDP until they are the one on the gurney at which point no expense should be spared.

Spiritrider, I've often wondered if those expenses listed in the studies is stuff that can be avoided (such as having a good grip on medical futility with the family on board, a solid POLST, etc).

[RogueDadMD]

 

Donnie wrote:

So there are the numbers on this situation.  In this example, you are $1,041 better off by withdrawing from the HSA today rather than saving receipts to invest tax free for use as a stealth IRA.

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Fun to see someone else down the rabbit hole of trading barbs.

The math as presented works as presented because it's math, but the scenario seems to miss a couple things, but I could be mistaken in a few things.  I'm honestly curious here, so please correct any misunderstandings I have.

• You seem to assume any future tax changes would favor a taxable account.  While I've no idea what will happen, at the moment HSA's seem to be gaining momentum to be more broadly available and able to be funded at a higher level, so they are unlikely to lose tax favored status anytime soon if they want people to use them.


• But then even if we stick with current tax rates, I am not sure why we are using 33% -- as WCI and others always point out, using current tax brackets, most of us should be in a LOWER bracket at retirement than we are now.


• You indicate that the whole receipt thing is fraught with issues -- sure, saving any document for long periods is fraught with issues.  But a lot of people make it to death without losing a birth certificate or social security card.  My receipts are saved on Dropbox and then uploaded to ConnectYourCare.  It is NOT difficult to save receipts.  It takes no more effort to "save" the receipts then to actually use those same receipts to get the money out immediately.  I still have to electronically submit those receipts to CYC to access my money immediately, which means I've scanned it into my computer and put it on Dropbox and then uploaded it to CYC.  So uploading them and then NOT withdrawing isn't really an effort issue, it's more a matter of do I think Dropbox and CYC will fail on the same day without chance of recovery of any documents.


• I'm not sure how you chose $5k as the expenditure amount as a lot of people will have more than $5k/year in expenses in years they fund an HSA.  You're specifically talking about high earners, and if you're on a HDHP that qualifies for an HSA, then by definition your deductible must be at least $2,700 for a family, but in most cases is far higher.  A high earner (your scenario) who is self-employed using an HDHP/HSA may have a deductible of $8k or $10k or higher.  They can easily rack up that much in costs a year before hitting the deductible, so if paying out of pocket they could actually accrue as much in health care expenditures as they do in HSA contributions AND growth.  I hit my out of pocket max in both 2015 AND 2016, but I'm fortunate that my OOP max is only $5500 (less than my HSA contributions).  But once I am paying for braces, I'll be racking up qualified expenditures that don't count towards those numbers, so I could easily pay more out of pocket than I contribute to the HSA.


• If you truly have only $5000 in expenditures to make tax free, AND you are somehow in a 33% bracket, then the math favors the taxable account (but I think those are assumptions that may not be accurate).  I'm too lazy to run the #'s and you seem like a #'s person, but what would the breakeven point in healthcare expenditures be to make the returns equal? Off hand it doesn't seem like a big change -- roughly $6k in expenditures (and thus tax free withdrawals) and the rest at your 33% ordinary income tax rates is about even

 

So while I do see scenarios where the math favors a taxable account, it really seems like you could make assumptions that are equally or more valid that could dramatically favor the HSA.

[FIREshrink]

Assuming qualified withdrawals it turns out the HSA advantage is measurable but not immense. A married couple can assume a lot of future health care expenses. The biggest drawback to the HSA-as-retirement account approach is the immediate taxation when inherited by a non spousal beneficiary. That should give us all pause, especially single investors.

Taking into account all factors, I've opted for option 1. Our HSA is a negligible part of our portfolio and is 100% invested in a low cost total international stock index fund. However every now and then I get tempted to stop with the receipt-keeping and just empty the whole thing (we've had enough qualified health care expenses in the last few years that we could do so without penalty). My stack of receipts is 2 feet high.

[Donnie]

jhwkr542 wrote:

Since when can couples put in $13k a year into their HSA?

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You are right, I typed that too quickly.

[jhwkr542]

Since when can couples put in $13k a year into their HSA?

[Donnie]

spiritrider wrote:

We will just have to agree to disagree.

Just because a person “can” take non-qualified HSA distributions >= age 65, pay ordinary income taxes and pay no penalties does not mean they “should” when they have substantial opportunity for future qualified tax-free HSA distributions.

You seem to think that some semantic purity to the made up term “Stealth IRA” is the only thing that matters. Instead of the sound financial reasons why it is not the optimal option.

WCI started this website for the financial benefit of the members. Your PhD in Physics and mathematical skills are not really relevant when, you are making a fundamentally specious argument to justify your recommendation. Especially when that recommendation is detrimental to the vast majority of the WCI community.

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What are you talking about?  It is seriously perplexing that you have made and continue to make statements about how damaging and detrimental my point of view is to the WCI community.  WCI and POF either are currently or are seriously considering cashing in their receipts now as opposed to saving them.  Others on the board also cash out receipts as the expenses are incurred.  Maybe I am in the minority on this board, I don't know.  Certainly HSA issues are not specific to doctors.

I am not making any specious arguments.  It is clear cut.  If you are going to use all of your HSA for qualified health expenditures, you are better off keeping your receipts.  If you are going to take non-qualified distributions, in many cases it may be better to cash them out now depending on your tax situation.  Why is this so controversial to you?

[spiritrider]

We will just have to agree to disagree.

Just because a person "can" take non-qualified HSA distributions >= age 65, pay ordinary income taxes and pay no penalties does not mean they "should" when they have substantial opportunity for future qualified tax-free HSA distributions.

You seem to think that some semantic purity to the made up term "Stealth IRA" is the only thing that matters. Instead of the sound financial reasons why it is not the optimal option.

WCI started this website for the financial benefit of the members. Your PhD in Physics and mathematical skills are not really relevant when, you are making a fundamentally specious argument to justify your recommendation. Especially when that recommendation is detrimental to the vast majority of the WCI community.

[Donnie]

I already said what I thought was inflammatory.  You claimed my math was mythical.  My PhD is in physics.  Rest assured, I take math very seriously.  If I am saying the math backs up what I am saying, I have actually done it.

You then moved the goal posts and said my logic and analysis was fundamentally false because OP didn't really mean Stealth IRA, he meant tax-free qualified withdrawals.  We can all speculate on what OP meant by saying Stealth IRA, but Stealth IRA has a meaning that is actually well defined on this very site.

To quote WCI:

• But even if you don’t need it for health care, you can treat it just like a traditional IRA once you hit age 65.  But it is even better than a traditional IRA for two reasons:  First, there is no income limit on deducting your contributions.  The contributions are deductible even if you make a million dollars a year.  Second, the contribution limit can be higher than the $5000 limit on traditional or Roth IRAs-$6150 ($3050 for individual coverage) for 2011.

Most people probably don't know that saving receipts and treating an HSA like a "stealth" traditional IRA is likely a bad decision for most high income earners based on the current tax code.  Furthermore, saving receipts is not riskless.  The tax code could change (no more tax free deductions for high income earners, no more carry forward of prior year receipts, etc.) or you could lose receipts.  Plowing ahead with receipt saving without understanding the risks or the benefits is a bad idea.

I agree that healthcare costs have outpaced inflation, but I highly doubt that it will continue like that in the future. How will anyone retire if you need $500k-$1M saved just for medical expenses.  69% of Americans have less than $1k of savings.

Your last point is off base because I am making the point about IRA-type withdrawals, not tax-free withdrawals. In the following example, the assumption is that the earnings from the investment will not be used for qualified health expenses.  If they are, then the amount should be reduced from $5,000 in the example until the returns would not be expected to be used for future health expenses.

If you have $5,000 in medical expenses this year you can either (i) use $5,000 of cash from you taxable account to pay the expenses and leave the HSA money untouched or (ii) withdraw the $5,000 from the HSA to pay the expenses and invest the $5,000 in your taxable account.

• Withdrawing from HSA and Investing in Taxable
  
  
  
  • Un-taxed Principal - $5,000
  
  
  • 30 year gains at 5.5% - $19,920
  
  
  • 30 year gains after 15% cap gains tax rate - $16,932
  
  
  • Total After Tax Amount - $21,932
  
  
  
  

• Savings Receipts and using HSA as Stealth IRA
  
  
  
  • Un-taxed Principal - $5,000
  
  
  • 30 year gains at 6.0% - $23,717
  
  
  • 30 year gains taxed at 33% ordinary income - $15,891
  
  
  • Total After Tax Amount - $20,891
  
  
  
  

So there are the numbers on this situation.  In this example, you are $1,041 better off by withdrawing from the HSA today rather than saving receipts to invest tax free for use as a stealth IRA.

[spiritrider]

Donnie wrote:

6% real return, friend.  5% real is $860k, more than the $500k you say is necessary.   It is you who is giving bad advice, making assumptions not in the OP, and dispensing with inflammatory comments that detract from a logical debate.

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I fail to see what is inflammatory about pointing out that the vast majority WCI members will benefit from paying HSA qualified medical expenses out of pocket and deferring tax-free distributions to accumulate the largest possible HSA balance for retirement qualified medical expenses. The vast majority if not virtually all forum members with HSAs will themselves and/or their spouses outlive their HSA balances. Thus rendering the fundamental premise of your argument specious.

You didn't mention in your prior response that you were referring to real returns. Not withstanding the likelihood of 6% real returns, you also neglected one significant point. If you are going to use real returns, then the nominal investment returns need to be biased against the correct inflation. Healthcare inflation has and will likely continue to rise at a significant faster rate than core inflation. So you need to factor that real increase into the projected retirement qualified medical expenses.

Finally, even though it will be a distinct minority of white coats who will find themselves with 30+ years of HSA eligibility. Lets even assume for sake of argument that in a perfect combination of events the HSA balance is too large. It is not an all or nothing proposition. A significant proportion of those compounded earnings from the unreimbursed receipts will have been distributed as tax-free disbursements rendering the net average ordinary tax liability of any non-qualified taxable distributions far lower than the actual marginal tax rate.

[Donnie]

Lithium wrote:

it’s a pretty big gamble to sacrifice eligibility to take out tax-free HSA withdrawals (on gains) on the assumption that LTCG will still get better tax treatment than unqualified HSA expenses several decades from now. But if you assume there are no health care expenses to worry about it makes sense.

I guess one could argue that it’s a gamble to assume that the traditional receipt saving strategy for qualified expenses won’t be shut down by regulation at some point either, but I’d rather take my chances with that.

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I agree with your concern that tax laws could change, but it is hard to speculate on how the tax code will look in 30 years.  For that reason, I try to take advantage of any breaks that I have now.  If tax-free qualified expense reimbursement is shut down for high earners, that would be far more detrimental to you than a change in cap gains taxes because now the whole receipt would be taxed at ordinary income levels.  Much better to take the cash now tax free if there is any significant risk of that happening in the future.

[Lithium]

it’s a pretty big gamble to sacrifice eligibility to take out tax-free HSA withdrawals (on gains) on the assumption that LTCG will still get better tax treatment than unqualified HSA expenses several decades from now. But if you assume there are no health care expenses to worry about it makes sense.

I guess one could argue that it’s a gamble to assume that the traditional receipt saving strategy for qualified expenses won’t be shut down by regulation at some point either, but I’d rather take my chances with that.

[Donnie]

6% real return, friend.  5% real is $860k, more than the $500k you say is necessary.   It is you who is giving bad advice, making assumptions not in the OP, and dispensing with inflammatory comments that detract from a logical debate.

[spiritrider]

I'm glad you find likely reality comical.

The problem is when you make a fundamentally flawed analysis/recommendation that can cause real harm to most forum members, that is not funny at all.

I think it is likely that the OP used the term "Stealth IRA", because that is the term he has heard for paying out of pocket and deferring reimbursement to allow the account to grow for retirement. I don't mean to speak for the OP and they can respond, but it is very likely they intend for the HSA to be primarily for it's intend purpose, especially in retirement when you really need it.

Your final paragraph is also flawed. You use a 30 year projected future HSA balance without also projecting what that Individual will have in qualified medical expenses starting retirement in those same 30 years. If a person retiring today can expect $250K, don't you think that will also be significantly higher in 30 years.

I stand by my rebuttal.

[Donnie]

spiritrider wrote:

Your evaluation is fundamentally false based on a faulty assumption. It assumes that HSA growth from those receipt amounts will be withdrawn as non-qualified distributions after age 65 subject to ordinary income tax.

Nothing could be further from the truth. You neglect the overwhelming qualified medical expenses you will see in retirement. Current estimates are that someone retiring today will have $250,000 in out of pocket healthcare expenses before they die.

Tax-free distribution for qualified medical expenses will include: Medicare Part B and D premiums including IRMAA (white coats will likely be in the higher tiers) currently can be as high as $500/month/person. Out-Of-Pocket expenses for medical, dental, vision and hearing care/products. All of which increase with age. Medigap premiums are not qualified, but you can self-insure a high-deductible plan to shift the non-qualified premiums to qualified co-pays and co-insurance. Not to mention, the 800lb. Gorilla, Long Term Care (LTC). You can anticipate significant cost for LTC insurance and/or self-insure.

For the average person/spouse, it will be virtually impossible for their HSA balance to out-live them/their spouse. Your recommendation and the assumption it is based on is fundamentally flawed.

This is why I dislike the term Stealth IRA. No one should be thinking about taking non-qualified HSA distributions after 65. You should be using other tax-deferred accounts first to preserve the HSA balance for tax-free distributions for qualified medical expenses. One the other hand, nobody should take Roth distributions before tax-free HSA distributions for unreimbursed qualified medical expenses. It is better to deplete the encumbered tax-free asset before the unencumbered one.

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Haha.  Comical response.  You deride me for "mythical math" and then later for "fundamentally false [math] based on faulty assumptions."

The math is not mythical and the stated use in the OP is a Stealth IRA, so I used no false assumptions, thanks.  You are imposing new assumptions, which is fine, but different from the stated HSA use in the OP.  In the case laid out in the OP, it is worse to save receipts to use as a stealth IRA than to cash out such receipts and invest them if the purpose of the HSA is for use as an IRA.

That's it.  Plain math.  Not controversial.  You have no idea what the health insurance situation is for OP or what OP's specific costs will be, so who knows whether your advice is accurate or not.  And by the way, a couple investing $13k per year at 6% in their HSAs will have over $1M in their HSAs after 30 years, so yes, even in your example there could easily be non-qualified HSA distributions.