HSA (health insurance) Math

[MadeInTheUSA]

I have what is probably a fairly basic math question that I can't seem to wrap my mind around.  I am switching over to a high-deductible HSA health insurance plan.  I am expecting to have to pay some of my doctors' fees upfront in cash.  I understand that, as long as these expenses occur after the start of the HSA plan, I can later withdraw money from the HSA tax-free to "reimburse" myself.  So let's say I pay $100 cash to the doctor; assuming a 33% tax rate, the real cost to me $150 of my gross (pre-tax) income.  It seems to me that if I reimburse myself $100 from my tax-advantaged HSA, I'm not truly recouping all my costs because my real cost was $150.  Am I missing something?

[bacchi]

HSA contributions are tax deductible.

You probably shouldn't pull out HSA money until it compounds tax-free for a long time, though.

[mre]

You probably shouldn't pull out HSA money until it compounds tax-free for a long time, though.

This.

If you used the HSA money for the doctor and invested the $100 in a taxable investment account, you pay taxes on the earnings.

If you leave the $100 in the HSA, you can invest it, and the earnings are tax free.  If used for medical expenses, you are never taxed on the money you contributed, or the earnings.  If not used for medical expenses, it operates largely like an IRA.

In 30 years, you can reimburse yourself from the HSA for earlier medical expenses, providing a means of non-taxed income, and leaving all of the earnings that money provided in the HSA for additional medical expenses.

This is as long as the rules aren't changed between now and then.

[MDM]

So let's say I pay $100 cash to the doctor; assuming a 33% tax rate, the real cost to me $150 of my gross (pre-tax) income.  It seems to me that if I reimburse myself $100 from my tax-advantaged HSA, I'm not truly recouping all my costs because my real cost was $150.  Am I missing something?

Scenario 1
The doctor wants $100.  You have $150 pre-tax.  You can either
- Pay $50 to the IRS and $100 to the doctor, or
- Put $150 into the HSA, withdraw $100 to pay the doctor, and leave $50 invested in the HSA.

Scenario 2
The doctor wants $100 now, and you will have another $100 bill next year.  You have $300 pre-tax.  Investments will earn 5%/yr.  You can either
- Pay $100 to the IRS, $100 to the doctor now, invest the remaining $100.  Next year, pay the doctor $100 and have $5 in your taxable investment.
- Put $300 into the HSA, withdraw $100 to pay the doctor now, and leave $200 invested in the HSA.  Next year, pay the doctor $100 and have $110 in your HSA investment.

The choice is yours.

[MadeInTheUSA]

This is helpful, bacchi and mre.

What I'm hearing you say is:

1) For now, I should expect to continue to pay medical expenses with my post-tax take-home cash (hitting my high deductible along the way).  I should start uploading receipts and keeping a running tab.
2) I should contribute to my HSA and think of it largely the way I think of my 401(k) (in terms of not withdrawing "early").
3) Then, in the far future, I can withdraw an amount up to the running tab of medical expenses.

Is this correct?  (It seems the point of an HSA, then, is not to use tax-free money to pay for my current medical expenses, but rather, to generate lots of tax-free earnings for future medical expenses).

=== Update after reading MDM's response ===

Good to hear from you again, MDM.  So it DOES seem that the point of an HSA is also to pay for current medical expenses with tax-free money, not just generate tax-free earnings for future expenses.  Based on your examples, I am obviously losing a shit ton of money if I pay my doctor with post-tax dollars.  I am seeing a out-of-network doctor who requires me to pay up front (therefore necessarily using post-tax dollars) (and then I get reimbursed on a coinsurance basis from my insurance company).  I don't want to stop seeing this doctor.  It seems that I should therefore do I can to get an exception to my doctor's policy (receive a bill from my doctor and get my insurance company to pay the bill from the HSA).  Is that right?

[omachi]

So let's say I pay $100 cash to the doctor; assuming a 33% tax rate, the real cost to me $150 of my gross (pre-tax) income.  It seems to me that if I reimburse myself $100 from my tax-advantaged HSA, I'm not truly recouping all my costs because my real cost was $150.  Am I missing something?

Scenario 1
The doctor wants $100.  You have $150 pre-tax.  You can either
- Pay $50 to the IRS and $100 to the doctor, or
- Put $150 into the HSA, withdraw $100 to pay the doctor, and leave $50 invested in the HSA.

Scenario 2
The doctor wants $100 now, and you will have another $100 bill next year.  You have $300 pre-tax.  Investments will earn 5%/yr.  You can either
- Pay $100 to the IRS, $100 to the doctor now, invest the remaining $100.  Next year, pay the doctor $100 and have $5 in your taxable investment.
- Put $300 into the HSA, withdraw $100 to pay the doctor now, and leave $200 invested in the HSA.  Next year, pay the doctor $100 and have $110 in your HSA investment.

The choice is yours.

Also note it's a bit different if you've maxed your HSA and have money left over to invest after-tax. No doubt maxing the HSA is awesome because you avoid payroll taxes. But then you have a choice of which pile to pay out of. Taxes are fixed. In this scenario you'll pay the IRS the same today regardless of the decision.

There are differences down the road, but they'll vary for each person. Any excess in the HSA past medical costs can be taken out at full retirement age like an IRA, paying taxes on it as income. If you can spend all of it on medical expenses, you're golden. If not, it's still better than an IRA, because you didn't pay payroll taxes.

If you will end up with a significant excess in the HSA beyond your medical expenses, you'd be in a worse boat if you decide to save the HSA funds and spend after-tax money, though. You'd only be paying capital gains taxes on money left in after-tax accounts, opposed to full income taxes on HSA excess.

Also worth looking at fees in your HSA's investment options and how your state treats capital gains.

[MDM]

Based on your examples, I am obviously losing a shit ton of money if I pay my doctor with post-tax dollars.

Also note it's a bit different if you've maxed your HSA and have money left over to invest after-tax. No doubt maxing the HSA is awesome because you avoid payroll taxes. But then you have a choice of which pile to pay out of. Taxes are fixed. In this scenario you'll pay the IRS the same today regardless of the decision.

Scenario 3
The doctor wants $100 now, and you will have another $100 bill next year.  You have $300 pre-tax and $200 post-tax.  Investments will earn 5%/yr, 3% from gain and 2% from dividends.  You pay 15%/yr tax on dividends and 15% on LTCG when withdrawn.  You can (among other options)
- $300 to HSA, pay $100 from the HSA to doctor now; next year pay doctor $100 from the HSA.  You will have $217.40 spendable in post-tax and $115.50 in your HSA: total $332.90.
- $300 to HSA, pay $100 from post-tax to doctor now; next year pay doctor $100 from post-tax.  You will have ~$4.70 spendable in post-tax and $330.75 in your HSA: total $335.45.

Scenarios 1 and 2 were to demonstrate that an HSA is clearly good thing to use for someone in a high tax bracket.

Scenario 3 shows that there is a slight preference (which will grow over time) to paying annually out of pocket instead of from the HSA.  As omachi notes, the overall optimum depends on the overall circumstances.

[MadeInTheUSA]

Thanks, omachi and MDM.  My takeaway is that (1) I should max out my HSA while I can, let it grow, and use down the road (hopefully all for medical expenses) and (2) it's not really a financial loss to me right now that my doctor requires post-tax cash payment from me.

[omachi]

Thanks, omachi and MDM.  My takeaway is that (1) I should max out my HSA while I can, let it grow, and use down the road (hopefully all for medical expenses) and (2) it's not really a financial loss to me right now that my doctor requires post-tax cash payment from me.

First, yes, max the HSA if you can. Assuming you contribute from your paycheck via your employer, you'll avoid the 6.2% payroll taxes that income otherwise is subject to, including your 401(k). Only downside is that the penalty for early withdrawal is higher (20% vs. 10%) and the age you can start getting it out for non-medical purposes without that penalty is higher.

That's really the big thing, especially if you're in a high tax bracket now and will be in a lower one later. The rest is smaller optimization.

Second, assuming you're maxing the HSA, you'll be slightly better off paying post-tax as long as you end up using all your HSA for medical expenses. But, if you have more room in a 401(k) or other similar account, paying from the HSA and putting excess in the 401(k) is arguably better than paying taxes on income to pay medical costs after tax and conserve the HSA funds.