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Taking HSA distributions
Old 07-07-2008, 11:39 AM   #1
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Taking HSA distributions

There seem to be two different approaches people take to HSA accounts:

1. Whenever you incur a medical expense, pay it out of the HSA account.
2. Avoid any distributions from the HSA account, so it grows tax free as long as possible.

So far I've been taking approach #1, mostly because I am not comfortable locking up a large amount of my wealth in an account where congress could add restrictions on what I can use it for, and where it definitely can't be used for daily living expenses.

But I'm considering taking the second approach, and I wanted to hear from those that are going that way.

If you're one who contributes to an HSA but pay medical expenses out of pocket rather than through HSA distributions, I'd like to hear your thinking... when are you planning on taking distributions? How are you planning on taking the distributions (by paying medical expenses or otherwise)?
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Old 07-07-2008, 11:49 AM   #2
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I set up an HSA last year and only take out for medical expenses. My plan provider doesn't provide many investment vehicles. If you want flexibility and tax free growth, an IRA should be the way to go. In my way of thinking anyways. I don't see how you could lock up a large amount of wealth in an HSA when max contributions are only 5-6K per year ! I am using the HSA for what it was designed for.
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Old 07-07-2008, 11:57 AM   #3
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My plan is that in 10-20 years I take out the money. It's grown tax free. I've got all my medical records to back up the medical use, including ibuprofen purchases for sore back.

Only problem is that I'm not paying much tax right now, so the advantage of the deduction isn't so great. But I still figure that the deduction and the tax-free compounding advantages will outweigh the extra fees.

In any case, it's almost a free lunch, and I can't resist it.

I'm not concerned that the laws will change concerning my existing contributions.

I'm a little concerned that when I take out $40,000 in one year, IRS drones will get confused: "This distribution relates to a purchase of ibuprofen 20 years ago? Wha?"

If we don't have enough medical expenses for all the money in the fund, I'll take it out after age 65 and pay tax on it.
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Old 07-07-2008, 11:59 AM   #4
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For me the HSA is like a ROTH IRA. It's a way to defer income, grow it tax free, and not be subject to RMD. My preferred option is to never use it.

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Old 07-07-2008, 11:59 AM   #5
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If you want flexibility and tax free growth, an IRA should be the way to go.
Ah, but not if you're retired and have no earned income.
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Old 07-07-2008, 11:59 AM   #6
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Originally Posted by frayne View Post
In my way of thinking anyways. I don't see how you could lock up a large amount of wealth in an HSA when max contributions are only 5-6K per year ! I am using the HSA for what it was designed for.
Many folks end up with big 401k balances even though the 401k contribution limits are lower than that. But 401k/IRA money can be used for anything (in retirement), so that makes some sense. Unless I know I'm going to face some big specific medical costs, I don't think I'd want a six figure HSA balance when death starts coming near.
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Old 07-07-2008, 12:11 PM   #7
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Originally Posted by free4now View Post
Many folks end up with big 401k balances even though the 401k contribution limits are lower than that. But 401k/IRA money can be used for anything (in retirement), so that makes some sense. Unless I know I'm going to face some big specific medical costs, I don't think I'd want a six figure HSA balance when death starts coming near.
Thought the 401k contribution limits were a LOT higher than 5-6k, I assume you mean IRA contribution limits?

FYI, 401k contribution limits for 2008 is $46,000, which is usually covered by employee and employer matches combined.
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Old 07-07-2008, 12:35 PM   #8
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Originally Posted by free4now View Post
Many folks end up with big 401k balances even though the 401k contribution limits are lower than that. But 401k/IRA money can be used for anything (in retirement), so that makes some sense. Unless I know I'm going to face some big specific medical costs, I don't think I'd want a six figure HSA balance when death starts coming near.
Of course, 401k and IRA are subject to RMD, while HSA is not.
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Old 07-07-2008, 12:59 PM   #9
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Originally Posted by free4now View Post
Many folks end up with big 401k balances even though the 401k contribution limits are lower than that. But 401k/IRA money can be used for anything (in retirement), so that makes some sense. Unless I know I'm going to face some big specific medical costs, I don't think I'd want a six figure HSA balance when death starts coming near.
I was under the impression that you can use the HSA money for anything
penalty-free once you are over some age (65?) although you have to pay
income taxes on the distributions......but still, no worse than IRA/401K.

The only disadvantage in my mind of leaving the HSA funds intact is that
you have to keep an eternity worth of medical records to document future
withdrawals and if you die before then, I'm not sure if your spouse can
use your past expenses to draw against, or worse, she may not know/understand HSA and fail to use it to advantage. Again, possibly no worse than 401K/IRA?
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Old 07-07-2008, 01:05 PM   #10
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Originally Posted by TromboneAl View Post
My plan is that in 10-20 years I take out the money. It's grown tax free. I've got all my medical records to back up the medical use, including ibuprofen purchases for sore back.

Only problem is that I'm not paying much tax right now, so the advantage of the deduction isn't so great. But I still figure that the deduction and the tax-free compounding advantages will outweigh the extra fees.

In any case, it's almost a free lunch, and I can't resist it.

I'm not concerned that the laws will change concerning my existing contributions.

I'm a little concerned that when I take out $40,000 in one year, IRS drones will get confused: "This distribution relates to a purchase of ibuprofen 20 years ago? Wha?"

If we don't have enough medical expenses for all the money in the fund, I'll take it out after age 65 and pay tax on it.
That's about what I'm considering doing. But I'm always looking for the downsides, and I see several ways this could go wrong:

- I just sold my 9 year old house, and was shocked that many of the receipts I had for home improvements had deteriorated to the point of being unreadable. The thermal receipt printers seem not to be designed for archiving, so I suppose I would have to scan the receipts and hope that I can make the electronic archive last 20 years.

- My records of which distributions had been taken/not taken could get lost.

- 20 years may not really be long enough for tax free compounding to really be worthwhile; about 30 years is when the logarithmic power of tax free compounding really kicks in. Here's an example.... Say that on average I would take or defer $1000 worth of HSA distros per year. If I'm in the 15% tax bracket, that means I save $150 of that on taxes. So I can model the amount of savings as a $150 annual contribution and the interest that earns over 10-20 years. Here's the numbers:

Years, Balance with no compounding, Balance with 5% real yearly compounded
10 $1500 $1,981
20 $3000 $5,207
30 $4500 $10,464
40 $6000 $19,025

So I would save $5207 in today's dollars worth of taxes if I deferred my $1000/yr HSA distros over 20 years. I would save $3000 even if I didn't defer, so the amount saved by the deferment itself is 5207-3000= $2207

That is certainly nothing to sneeze at, but it comes at the expense of $1000/year higher "burn rate", which like taking on a mortgage or any other expense tends to reduce portfolio survival in bad cases.

I suppose that because this HSA distro deferral is flexible, one doesn't need to do it every year.

So writing this all out gives me a third option for how to use the HSA account, one which I think might subscribe to, for smoothing expenses:

3. Take HSA distributions only in years when spending exceeds 4% (or your target) of net worth, and defer in years when spending is less.

I'm currently spending 5% rather than 4% of my nest egg due to a move, and I'm young, so I'm perhaps a bit more focussed on controlling my burn rate than others might be.
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Old 07-07-2008, 01:24 PM   #11
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Originally Posted by CitricAcid View Post
Thought the 401k contribution limits were a LOT higher than 5-6k, I assume you mean IRA contribution limits?

FYI, 401k contribution limits for 2008 is $46,000, which is usually covered by employee and employer matches combined.
Uh, yeah, I meant IRA limits... thanks for the correction.
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Old 07-07-2008, 01:35 PM   #12
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Part of the consideration needs to be what funds the HSA?

For me, my choice is 401k or HSA. I cannot afford to max both out- so I want something in m HSA which I will spend that year, the rest goes into 401k- which I do not touch.

Maxing the Roth's is a given (for both spouses).

The question might have different flavors for different people:

1) do you max the HSA
2) do you withdraw from the HSA for current medical expenses

Then look at same set of questions with these in addition to #1:
1a) do you max Roth and 401k?
1b) do you have other retirement savings available (taxable accounts or other)?
1c) do you have other savings (house, kids education, other)
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Old 07-07-2008, 01:48 PM   #13
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Originally Posted by free4now View Post
There seem to be two different approaches people take to HSA accounts:
1. Whenever you incur a medical expense, pay it out of the HSA account.
2. Avoid any distributions from the HSA account, so it grows tax free as long as possible.
I'm in year 2 with an HSA and have put in the max so far. I am following approach #2 for the tax benefits. However, now that I see the actual investment choices in my HSA which are essentially variations on MMF's, I am more than a little disappointed. So I am on the fence about the benefit of the plan I was offered...
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Old 07-07-2008, 02:24 PM   #14
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Quote:
Originally Posted by jIMOh View Post
Part of the consideration needs to be what funds the HSA?

For me, my choice is 401k or HSA. I cannot afford to max both out- so I want something in m HSA which I will spend that year, the rest goes into 401k- which I do not touch.

Maxing the Roth's is a given (for both spouses).

The question might have different flavors for different people:

1) do you max the HSA
2) do you withdraw from the HSA for current medical expenses

Then look at same set of questions with these in addition to #1:
1a) do you max Roth and 401k?
1b) do you have other retirement savings available (taxable accounts or other)?
1c) do you have other savings (house, kids education, other)
I've had an HSA since '05
Started maxing it '07 (will continue)
Do not withdraw for current medical expenses

Am retired, can not contribute to IRA or TSP (have not withdrawn from either)
Have CDs and MMA
House is paid for, no spouse, no kids

I see HSA as another way of saving money and reducing taxes.

BTW, what are the rules on inheriting an HSA?
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Old 07-07-2008, 02:56 PM   #15
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Another related question: for those of you who are not taking distributions from your HSAs, what is your recordkeeping system for medical expenses?

This year I started a spreadsheet of medical expenses, with a column that I fill in when I pay it from the HSA. I keep my receipts for the medical expenses in the current year's tax file folder, and move them forward into the next year's tax folder if deferred. Then if the receipts start getting faded I will probably scan them into the computer.
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Old 07-07-2008, 03:58 PM   #16
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Ah, but not if you're retired and have no earned income.

Excellent point !
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Old 07-07-2008, 09:20 PM   #17
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Ah, but not if you're retired and have no earned income.
IRS Pub 969 is all about health savings accounts (Publication 969 (2007), Health Savings Accounts and Other Tax-Favored Health Plans).

To be eligible, you need a high deductible health plan and not be enrolled in Medicare (among other things). I see no reference to requiring earned income. You receive tax-free distributions from an HSA for qualified medical expenses; otherwise you will be taxed on those distributions. I see no reference to when you have to incur those medical expenses.

I take this to mean you can make contributions to an HSA if you have a HDHP (whether or not you have a job) until you enroll in Medicare and can take tax-free medical-related distributions at any time (such as long-term care costs you might incur many years after you have retired and are enrolled in Medicare).

I also believe not all states have accepted HSA as a tax-free vehicle for health care (e.g., California, where I live). So my HSA is treated the same as a mutual fund would be treated (no deduction for the annual contribution, and gains and losses are taxed each year). Turbotax supports my assertion in that my HSA contributions aren't deductible on my California return (and I see articles in the press every once in a while about how California has yet to pass the bill that would bring its HSA law in sync with Federal law).

I could be wrong about the above information, since I'm neither a lawyer nor tax specialist.
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Old 07-08-2008, 12:46 AM   #18
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Very interesting about the California treatment of HSAs... I just opened my California turbotax return from 2007 and indeed the $2850 I contributed to my HSA is treated as an "adjustment to income" on Schedule 540 line 25, "hsa deduction". Meaning even though I don't pay federal tax on it, I did pay California tax on it
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Old 07-08-2008, 07:33 AM   #19
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I use it. I figure that while the RMD consideration is a valid one, especially after the last few months if I *do* have a large enough 401K/TIRA to throw my RMDs into a punitive tax bracket, I'll have a lot more than I expect to have and that's not a bad problem to have.
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Old 07-08-2008, 07:58 AM   #20
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- I just sold my 9 year old house, and was shocked that many of the receipts I had for home improvements had deteriorated to the point of being unreadable. The thermal receipt printers seem not to be designed for archiving, so I suppose I would have to scan the receipts and hope that I can make the electronic archive last 20 years.

- My records of which distributions had been taken/not taken could get lost.

what is your recordkeeping system for medical expenses?
That was my concern also. Every medical receipt gets scanned in to the computer. I've set up a computer macro so that I can press one button and get the thing scanned in. All the files go into a special computer folder for medical/dental/vision expenses, with a subfolder for each year. I back up all my computer's documents to DVD every two weeks, and some of these are stored in a safe deposit box. In addition, all the paper copies go into a physical file folder. Finally, all data is recorded in Quicken (automatically from checking and CC data downloads).

----------

Yes, at age 65, you can take out HSA money for any purpose without penalty (but it is taxable if not used for medical expenses).
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