Author Topic: Kill Student Loans or Build HSA - What Would You Do?  (Read 7172 times)

AlwaysLearningToSave

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Kill Student Loans or Build HSA - What Would You Do?
« on: September 23, 2015, 09:58:10 PM »
We will likely be making changes to our health insurance come January 1, and I would like your input on what we should prioritize with additional cash flow. 

Current Situation:

I am covered by employer-sponsored health insurance, and my portion of the premium is $86.30 per month.  My wife and one year old daughter are on a gold-level private insurance plan at $680.82 per month (chosen before discovering MMM, but not a bad choice at the time considering the uncertainty over my daughter's health condition at the time).  My daughter has a rare digestive health condition that necessitates a $611.68 monthly purchase of prescription formula (long story, just take my word for it).  The formula cost is not covered by insurance but half of the cost is reimbursed through a state program for a net expense of $305.84 per month.  I have a Flex Spending Account to which we elected to contribute $125 per month this year.  Thus, current healthcare spending is as follows:

$86.30 (Husband)
$680.82 (Wife/Daughter)
$305.82 (Unreimbursed/not covered formula)
$125.00 (FSA)
$1197.94 Total Health Care Expenses Per Month.

Ugh.  Now you know why we want to make changes.

My wife also has approximately $22,000 in student loans at 6.8% that we loath and want to murder in cold blood.  We currently pay $525 per month toward those loans, which is $200 more than the minimum on the traditional 10-year amortization.

We have an emergency fund of about two months' expenses, or $6,500. 

We want to move at least wife and daughter to a HDHP to qualify for a health savings account which should free up some cash flow.  Let's assume that wife and daughter can get HDHP coverage with a $5000 deductible for $450 per month, which frees up some cash flow.  Also assume that $200 of the formula expense can be paid from the HSA (this is a highly technical tax question, let's just assume this is correct for now).  Let's also assume Husband's monthly insurance premium is $95 next year. 

We are wrestling with two different potential scenarios:  Scenario One would be to use additional cash flow to kill the student loans.  Scenario Two would be to use additional cash flow to first max out the HSA and then pay down the student loan debt with the remaining cash flow.  The following table illustrates the current situation as compared to the two future scenarios (please excuse the formatting, I cannot figure out how to copy and paste a spreadsheet into the forum):

                                                                Current           Scenario 1   Scenario 2
Expenses:                                                                    (Kill Loans)   (Build HSA)
Wife / Daughter Health Ins.                        680.82            450                    450
Husband Health Ins.                                      86.30            95                    95
Flex Spending Account                             125.00             0                     0
Unreimbursed Taxable Formula Expense     305.82            105.82            105.82
         
Savings / Debt Payments         
Student Loan                                                825            1172.12            809.62
Health Savings Account Contributions         0              200                    562.5
         
Total Cash Flow:                                      2022.94   2022.94            2022.94

Assuming no major medical expenses, the result at the end of one year for Scenario One will be $0 in the HSA (all money that flows in is spent on formula) but we will have paid 14065.44 toward the student loan (an additional $4350 over Option Two).  The result in Scenario Two is $4350 in the HSA pre-tax but only $9715.44 paid toward student loan. 

Essentially the difference is risk.  If we incur significant medical expenses during the year in Scenario 1, we could cut back to minimum on student loan payments and free up around $800 per month to make payments on the medical expenses.  In Scenario 2, we make pre-tax HSA contributions that almost cover the HDHP deductible but do not save as much in interest on the loans.  If we incur medical expenses, we don't need to change much at all... we just keep funneling money through the HSA to pay the medical expenses. 

What are your thoughts?  Would you pursue paying the loans first or building the HSA? 

MDM

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #1 on: September 23, 2015, 10:11:38 PM »
...cannot figure out how to copy and paste a spreadsheet into the forum)
http://forum.mrmoneymustache.com/forum-information-faqs/how-to-formatting-a-table/

Quote
What are your thoughts?  Would you pursue paying the loans first or building the HSA?
With the HSA you save your marginal tax rate.  Assuming
 - the marginal tax rate is higher than the student loan interest rate, and
 - the health condition means the HSA is more likely to be a spending conduit than an investment location,
doing the HSA seems better.  But you should run the numbers to be sure.

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #2 on: September 24, 2015, 07:11:59 AM »
Quote
What are your thoughts?  Would you pursue paying the loans first or building the HSA?
With the HSA you save your marginal tax rate.  Assuming
 - the marginal tax rate is higher than the student loan interest rate, and
 - the health condition means the HSA is more likely to be a spending conduit than an investment location,
doing the HSA seems better.

There is less uncertainty about the health condition than there used to be.  While it requires the expensive formula purchase, we do not anticipate it causing significant additional medical expenses (knock on wood).  Thus, to the extent the HSA can be used for the cost of formula, it will be used as a spending conduit.  Otherwise it would be used as a medical emergency fund and perhaps a spending conduit for additional routine medical expenses.  The ultimate goal is for it to be a piece of our retirement savings.

But you should run the numbers to be sure.

I will try to do so, though I suspect this will stretch my spreadsheet-making abilities.

I'm also curious about peoples' qualitative opinions on how much of a medical emergency fund is necessary.  It makes me a bit uncomfortable to think about not having dedicated cash available to meet the deductible if needed but my wife is more interested in killing her student loans than sitting on a cushion of cash with strings attached.
« Last Edit: September 24, 2015, 07:13:56 AM by AlwaysLearningToSave »

MDM

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #3 on: September 24, 2015, 03:40:29 PM »
I will try to do so, though I suspect this will stretch my spreadsheet-making abilities.
You could modify the attached if you don't want to start with a blank sheet.  No guarantees as to whether that will be helpful or not. ;)

Inputs cells are in light green.  Spreadsheet is protected but with no password so (in Excel 2013) Review>Unprotect Sheet will open it for editing.

Major assumptions:
  1) You have post-tax cash equal to your SL payment, plus pre-tax cash equal to your HSA maximum.
  2) The pre-tax cash can go into the HSA, or you can pay tax and then pay more on the SL if it is still active, or invest taxably if the SL has been paid.
  3) Money to pay medical expenses is available, and is above and beyond that in #1.
  4) Annual payments.  Change cell B5 to 12 for monthly payments, but then you'll also need to add 84-7=77 rows to the calculation table.

Known shortcomings:
  - Does not account for taxation of taxable returns, nor capital gain taxes needing payment to get net spendable from the taxable account.
  - Does not account for taxation of HSA withdrawals if not used for medical expenses

Short conclusion: based on the above assumptions, and further assuming the spreadsheet is built correctly, fund the HSA to the max and don't pay any extra on the SL unless you have cash flow beyond that.  Change cell B12 and watch cell S26.

Quote
I'm also curious about peoples' qualitative opinions on how much of a medical emergency fund is necessary.  It makes me a bit uncomfortable to think about not having dedicated cash available to meet the deductible if needed but my wife is more interested in killing her student loans than sitting on a cushion of cash with strings attached.
I wouldn't keep a medical emergency fund in addition to an emergency fund, but would recognize that "loss of income" and "extraordinary medical expense" are two major reasons one might need to tap an e-fund.  Up to you to estimate the likelihood of both happening simultaneously.  If assuming only one at any given time, "some number of months of income" may not differ much from "the full deductible for an HDHP."

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #4 on: September 24, 2015, 03:54:45 PM »
Thanks for the spreadsheet.  I'll check it out.  I suspect I will need to change a few assumptions, particularly the assumption about "pre-tax" part.  I likely will not be able to make the HSA contributions via payroll deduction, so I will save the marginal tax rate but not be able to avoid payroll tax.  Haven't looked at the spreadsheet yet, but that is the biggest discrepancy I anticipate.

I wouldn't keep a medical emergency fund in addition to an emergency fund, but would recognize that "loss of income" and "extraordinary medical expense" are two major reasons one might need to tap an e-fund.  Up to you to estimate the likelihood of both happening simultaneously.  If assuming only one at any given time, "some number of months of income" may not differ much from "the full deductible for an HDHP."

I suppose the concern I have is that if "extraordinary medical expense" happens, there is a strong possibility it the event will also at least temporarily reduce future income.  Our emergency fund would disappear pretty quickly if we needed to rely upon in for both living expenses and medical expenses. 

seattlecyclone

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #5 on: September 24, 2015, 04:30:20 PM »
I suppose the concern I have is that if "extraordinary medical expense" happens, there is a strong possibility it the event will also at least temporarily reduce future income.  Our emergency fund would disappear pretty quickly if we needed to rely upon in for both living expenses and medical expenses. 

This is why you should buy disability insurance. Many people who really should have it don't, and experience financial ruin in cases where they are unable to work for an extended period.

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #6 on: September 24, 2015, 09:36:43 PM »
I suppose the concern I have is that if "extraordinary medical expense" happens, there is a strong possibility it the event will also at least temporarily reduce future income.  Our emergency fund would disappear pretty quickly if we needed to rely upon in for both living expenses and medical expenses. 

This is why you should buy disability insurance. Many people who really should have it don't, and experience financial ruin in cases where they are unable to work for an extended period.

Agreed.  Already have it, and it is a pretty good policy.  But even a good policy only replaces a fraction of your pre-disability income.

MDM (or others who are interested):  I've attached a spreadsheet that runs the calculations on three different savings scenarios.  I added a hybrid approach that maxes the HSA until the HSA balance is $5,000.00 then lets the HSA balance sit while killing the loans.

I'd appreciate if you take a look and ensure the spreadsheet is set up properly and give me your thoughts on the different outcomes, both in terms of long term results and emergency preparedness in the meantime.  There is a clear winning scenario and losing scenario from a pure dollars and cents perspective, but significant differences in our medical emergency fund in the midst of the scenarios.

« Last Edit: September 25, 2015, 07:04:17 AM by AlwaysLearningToSave »

MDM

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #7 on: September 24, 2015, 11:14:50 PM »
ALTS, nice work - particularly getting the SL payment/interest/principal part right!  Didn't do an exhaustive check but spot checks looked good.

To make things easier on yourself, consider putting each assumption in its own cell, then referencing that cell in formulas instead of having pure numbers in cell formulas.  E.g., for "HSA assumes 1%", put 1% in a cell and then use that cell instead of 0.01 in formulas.  Same for assuming 15% marginal rate: put 15% in a cell and use (1 - that cell) in formulas instead of 0.85.

Is state tax included in that 15% assumption?

If you are willing to invest the HSA funds, you could do better than 1% returns.  You could also, of course, do worse.

What about a scenario that pays the minimum SL payment until you hit the HSA maximum for the calendar year?

The higher the marginal tax rate and HSA returns, the more favorable the HSA.  The lower the marginal tax rate and HSA returns, the more favorable SL payoff.

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #8 on: September 25, 2015, 07:32:33 AM »
Thanks, MDM.

To make things easier on yourself, consider putting each assumption in its own cell, then referencing that cell in formulas instead of having pure numbers in cell formulas.  E.g., for "HSA assumes 1%", put 1% in a cell and then use that cell instead of 0.01 in formulas.  Same for assuming 15% marginal rate: put 15% in a cell and use (1 - that cell) in formulas instead of 0.85.

I tried to do this, but when I would drag the formula into subsequent cells, Excel's "smart" system assumed I wanted to reference the next cell down.  I could not figure out how to override this assumption and create a static cell reference.  I suppose the workaround could be inserting a new column that repeatedly states the assumption, but that doesn't seem much more helpful than what I did.  Is there an easy way to create a static cell reference in a formula?

Is state tax included in that 15% assumption?

. . .

The higher the marginal tax rate and HSA returns, the more favorable the HSA.  The lower the marginal tax rate and HSA returns, the more favorable SL payoff.

No, only federal.  Good thought.  I'm not sure what my state tax marginal rate would be, so I will have to look that up and include it.  While I'm betting we would stay in the 15% marginal tax bracket given my wife only works part time, it is conceivable that we would go up a bracket in subsequent years with raises, bonuses, side gigs, etc.

EDIT:  State marginal tax rate is 6.84% on top of the federal 15% marginal rate for total of 21.84%.  That will make a big difference!

If you are willing to invest the HSA funds, you could do better than 1% returns.  You could also, of course, do worse.

Agreed.  I wanted to keep the estimates conservative.  To the extent we use the HSA as only a spending conduit, I will keep the money in cash-equivalents.  Beyond that, I would intend to keep the HSA in relatively conservative investments in the short term because it will serve as a medical emergency fund.  Long term, I would want the HSA to be a piece of long-term retirement savings.  Again, I might place the conservative investments in my portfolio in the HSA to keep its balance relatively stable. 

What about a scenario that pays the minimum SL payment until you hit the HSA maximum for the calendar year?

That is an interesting idea I had not considered.  It seems this could be more advantageous than the hybrid scenario I already included.  Looks like we could reach the annual max in less than 6 months, which will then allows to start making bigger principal payments sooner. 

I will have to run the numbers with my new-found Excel skills!
« Last Edit: September 25, 2015, 07:42:56 AM by AlwaysLearningToSave »

MDM

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #9 on: September 25, 2015, 11:26:13 AM »
I tried to do this, but when I would drag the formula into subsequent cells, Excel's "smart" system assumed I wanted to reference the next cell down.  I could not figure out how to override this assumption and create a static cell reference.  I suppose the workaround could be inserting a new column that repeatedly states the assumption, but that doesn't seem much more helpful than what I did.  Is there an easy way to create a static cell reference in a formula?
Great question.  Answer is yes: putting a dollar sign in front of the column/row keeps that static when you copy.  E.g., $A1 will always refer to column A, A$5 will always refer to row 5, and $C$6 will always refer to cell C6.  When you enter (or edit) a formula, hitting F4 when the cursor is on a cell reference will change the address from relative (no $) to absolute (2 $) to the two different 1 $ options, and back to no $.

Quote
I will have to run the numbers with my new-found Excel skills!
Enjoy!

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #10 on: September 25, 2015, 01:07:02 PM »
What about a scenario that pays the minimum SL payment until you hit the HSA maximum for the calendar year?

Quote
I will have to run the numbers with my new-found Excel skills!
Enjoy!

MDM:  Please see the spreadsheet attached under the new "Hybrid 2" tab.  I suspected this would give the best results but I am surprised by how stark the contrast is between in and the other scenarios.  This approach seems to me to be the best of all worlds because it quickly creates a medical emergency fund, maximizes tax savings, kills the student loans only two months later than concentrating all effort on killing loans, AND results in the greatest overall wealth at the end of the calculation period.

I used the static cell shortcuts and like it a lot.  That will make spreadsheet creation much easier in the future. 

I'd be grateful if you took a peek to make sure I didn't obviously screw anything up. 

« Last Edit: September 25, 2015, 01:08:36 PM by AlwaysLearningToSave »

MDM

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #11 on: September 25, 2015, 01:17:19 PM »
This approach seems to me to be the best of all worlds because it quickly creates a medical emergency fund, maximizes tax savings, kills the student loans only two months later than concentrating all effort on killing loans, AND results in the greatest overall wealth at the end of the calculation period.

I used the static cell shortcuts and like it a lot.  That will make spreadsheet creation much easier in the future. 

I'd be grateful if you took a peek to make sure I didn't obviously screw anything up.

Nice work!  No problems from a quick check.  One question: what about repeating the 2016 contribution pattern (front-loading HSA) in 2017?

therethere

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #12 on: September 25, 2015, 01:24:20 PM »
I didn't read all the comments. But an important thing to note:

If you have an HSA, you may use the funds on anyone in your family, regardless of whether they themselves are on an HDHP plan or not. However, you may only contribute up to the individual max (~3500) versus the family max (~6500). With this in mind, see if it makes sense to get the healthiest person on an HDHP to open an HSA. Then leave your daughter and whoever you expect will utilize insurance the most on a PPO or "gold level" plan as you put it. This way you will have the benefits of the lower out of pocket costs on anyone who has known issues but also get the benefit of the pretax HSA money.

Also, you cannot use HSA funds to pay for health insurance deductibles premiums. The exception is COBRA and deductibles premiums after some age or some specific type (forget exact age but there is one set). Now that I read your spreadsheet I see you realize this.

If you can get an HDHP through your employer, HSA contributions from  your regular paycheck skip FICA taxes. That's an additional 7.6% tax savings.
« Last Edit: September 25, 2015, 01:41:09 PM by therethere »

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #13 on: September 25, 2015, 01:33:52 PM »
I didn't read all the comments. But an important thing to note:

If you have an HSA, you may use the funds on anyone in your family, regardless of whether they themselves are on an HDHP plan or not. However, you may only contribute up to the individual max (~3500) versus the family max (~6500). With this in mind, see if it makes sense to get the healthiest person on an HDHP to open an HSA. Then leave your daughter and whoever you expect will utilize insurance the most on a PPO or "gold level" plan as you put it. This way you will have the benefits of the lower out of pocket costs on anyone who has known issues but also get the benefit of the pretax HSA money.

This is not quite accurate.  An eligible individual with family HDHP coverage can contribute up to the family max ($6,750 in 2016) even if the eligible individual's spouse is covered by a non-HDHP.  "Family coverage" is defined as anything other than self-only coverage.  Thus, if Wife and Daughter are covered by a HDHP and Husband is covered by a non-HDHP, Wife is an eligible individual who can contribute to an HSA up to the family maximum.  HSA funds distributed from the HSA to pay medical expenses for any of Wife, Husband, or Daughter may be excluded from income. 

See Rev. Rul. 2005-25, found here: http://www.irs.gov/pub/irs-drop/rr-05-25.pdf

Compare Scenario 1 to Scenario 2.  Note that the laws have changed regarding maximum contribution limits, but the revenue ruling still serves as proof of concept regarding family coverage and family contribution limit.

therethere

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #14 on: September 25, 2015, 01:38:00 PM »
I agree with the commenter above and that is how I understand the rules also. I assumed because DD is the one with medical issues that it would be beneficial to her on a PPO vs HDHP. Thus, one parent would be on an individual plan HDHP. With the other and DD on a PPO plan. It was a pure guess though. That may not fit the situation if medical issues were a one time only thing before they figured out the formula issue.

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #15 on: September 25, 2015, 01:38:59 PM »
Also, you cannot use HSA funds to pay for health insurance deductibles. The exception is COBRA and deductibles after some age (forget exact age but there is one set). Now that I read your spreadsheet I see you realize this.

Also not accurate, but I'm assuming you meant to say health insurance premiums

If you can get an HDHP through your employer, HSA contributions from  your regular paycheck skip FICA taxes. That's an additional 7.6% tax savings.

Wish I could, but likely will not be able to. 

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #16 on: September 25, 2015, 01:43:02 PM »
I agree with the commenter above and that is how I understand the rules also. I assumed because DD is the one with medical issues that it would be beneficial to her on a PPO vs HDHP. Thus, one parent would be on an individual plan HDHP. With the other and DD on a PPO plan. It was a pure guess though. That may not fit the situation if medical issues were a one time only thing before they figured out the formula issue.

Now I see what you are getting at.  For some people this may be true but for our situation it is not because of the way my employer structures its health insurance offerings.  Family premiums are extraordinarily expensive under my employer's plan.  It does not make financial sense for our family to do anything other than DW and DD on HDHP, with me on self-only PPO coverage offered by employer. 
« Last Edit: September 25, 2015, 01:47:00 PM by AlwaysLearningToSave »

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #17 on: September 25, 2015, 01:50:23 PM »
This approach seems to me to be the best of all worlds because it quickly creates a medical emergency fund, maximizes tax savings, kills the student loans only two months later than concentrating all effort on killing loans, AND results in the greatest overall wealth at the end of the calculation period.

I used the static cell shortcuts and like it a lot.  That will make spreadsheet creation much easier in the future. 

I'd be grateful if you took a peek to make sure I didn't obviously screw anything up.

Nice work!  No problems from a quick check.  One question: what about repeating the 2016 contribution pattern (front-loading HSA) in 2017?

I thought about running it that way as well.  I will have to check it out.  By that time the minimum student loan payment ought to be lower as well, allowing us to front-load the HSA faster.
« Last Edit: September 25, 2015, 01:52:05 PM by AlwaysLearningToSave »

TomTX

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #18 on: September 26, 2015, 09:04:24 AM »
Shit, there's no place cheaper you can get this insanely expensive formula? No drop ship from Canada or Finland or something?

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #19 on: September 26, 2015, 05:14:55 PM »
Shit, there's no place cheaper you can get this insanely expensive formula? No drop ship from Canada or Finland or something?

It is ridiculously expensive. This is the best price we've been able to find. Most places don't carry it and pharmacies have to special order it. We try solid foods one at a time and have found a handful of vegetables she can eat but she doesn't have a complete diet of safe solid foods so needs the formula for nutrients. We pray for the day she has a complete diet. Even if we need to pay a lot for unusual foods, practically anything is cheaper than this formula.

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #20 on: September 27, 2015, 07:12:48 AM »
This approach seems to me to be the best of all worlds because it quickly creates a medical emergency fund, maximizes tax savings, kills the student loans only two months later than concentrating all effort on killing loans, AND results in the greatest overall wealth at the end of the calculation period.

I used the static cell shortcuts and like it a lot.  That will make spreadsheet creation much easier in the future. 

I'd be grateful if you took a peek to make sure I didn't obviously screw anything up.

Nice work!  No problems from a quick check.  One question: what about repeating the 2016 contribution pattern (front-loading HSA) in 2017?

I've attached a much cleaner version of the spreadsheet, including an additional calculation that assumes front-loading of the HSA in both 2016 and 2017.  The sheet also includes a more realistic marginal tax rate that contemplates both state and federal taxes.  And it is now set up in a more flexible way that allows you to more easily change assumptions like investment returns.  There must have been some sort of error in my original sheet because it is now showing that scenario one ($200 to HSA for formula each month, everything else killing student loans) provides the maximum overall wealth at the end of the calculation period. 

Despite the numbers, I still lean toward Hybrid 2 (front-load the HSA in 2016 ASAP, then kill the loans) because it provides a more comfortable emergency fund during the pay-down period.  Before having to replace an air conditioner this summer, we had a $10,000 emergency fund.  $6,500 feels less comfortable.  Hybrid 2 allows us to build our emergency fund back up in a manner that is least detrimental to our long term financial position.  The obvious downside is that the HSA money is restricted to medical expenses unless we pay the additional 10% tax. 

Another reason I still lean toward Hybrid 2 is that we still need to explore refinancing the student loans.  The lower the interest rate on the student loan, the less pronounced the difference between Situation 1 and Hybrid 2.

Any other thoughts?

Thanks again for helping me work through the question!


AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #21 on: September 27, 2015, 10:34:08 AM »
One more question:  How should I manage my W-4 to accomplish front-loading the HSA?  I see a couple alternatives but don't really know that much about the payroll withholding process. 

The first way I could do it would be to submit a W-4 for January, such that I claim lots of exemptions to have maximum access to pre-tax dollars which would then be funneled into the HSA.  Upon maxing out the HSA, I would then need to submit a new W-4 claiming fewer exemptions to increase my withholding in hopes of having no tax owed or refund due at the end of the year. 

Alternatively, I could keep the W-4 exemptions the same throughout the whole year.  This would reduce my access to pre-tax money during the HSA building process, meaning the account would be built slower.  But I would have more post tax dollars available during the period in which we are throwing everything at the Student Loans. 

Thoughts? 

clarkevii

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #22 on: September 27, 2015, 10:44:09 AM »
We will likely be making changes to our health insurance come January 1, and I would like your input on what we should prioritize with additional cash flow. 

Current Situation:

I am covered by employer-sponsored health insurance, and my portion of the premium is $86.30 per month.  My wife and one year old daughter are on a gold-level private insurance plan at $680.82 per month (chosen before discovering MMM, but not a bad choice at the time considering the uncertainty over my daughter's health condition at the time).  My daughter has a rare digestive health condition that necessitates a $611.68 monthly purchase of prescription formula (long story, just take my word for it).  The formula cost is not covered by insurance but half of the cost is reimbursed through a state program for a net expense of $305.84 per month.  I have a Flex Spending Account to which we elected to contribute $125 per month this year.  Thus, current healthcare spending is as follows:

$86.30 (Husband)
$680.82 (Wife/Daughter)
$305.82 (Unreimbursed/not covered formula)
$125.00 (FSA)
$1197.94 Total Health Care Expenses Per Month.

Ugh.  Now you know why we want to make changes.

My wife also has approximately $22,000 in student loans at 6.8% that we loath and want to murder in cold blood.  We currently pay $525 per month toward those loans, which is $200 more than the minimum on the traditional 10-year amortization.

We have an emergency fund of about two months' expenses, or $6,500. 

We want to move at least wife and daughter to a HDHP to qualify for a health savings account which should free up some cash flow.  Let's assume that wife and daughter can get HDHP coverage with a $5000 deductible for $450 per month, which frees up some cash flow.  Also assume that $200 of the formula expense can be paid from the HSA (this is a highly technical tax question, let's just assume this is correct for now).  Let's also assume Husband's monthly insurance premium is $95 next year. 

We are wrestling with two different potential scenarios:  Scenario One would be to use additional cash flow to kill the student loans.  Scenario Two would be to use additional cash flow to first max out the HSA and then pay down the student loan debt with the remaining cash flow.  The following table illustrates the current situation as compared to the two future scenarios (please excuse the formatting, I cannot figure out how to copy and paste a spreadsheet into the forum):

                                                                Current           Scenario 1   Scenario 2
Expenses:                                                                    (Kill Loans)   (Build HSA)
Wife / Daughter Health Ins.                        680.82            450                    450
Husband Health Ins.                                      86.30            95                    95
Flex Spending Account                             125.00             0                     0
Unreimbursed Taxable Formula Expense     305.82            105.82            105.82
         
Savings / Debt Payments         
Student Loan                                                825            1172.12            809.62
Health Savings Account Contributions         0              200                    562.5
         
Total Cash Flow:                                      2022.94   2022.94            2022.94

Assuming no major medical expenses, the result at the end of one year for Scenario One will be $0 in the HSA (all money that flows in is spent on formula) but we will have paid 14065.44 toward the student loan (an additional $4350 over Option Two).  The result in Scenario Two is $4350 in the HSA pre-tax but only $9715.44 paid toward student loan. 

Essentially the difference is risk.  If we incur significant medical expenses during the year in Scenario 1, we could cut back to minimum on student loan payments and free up around $800 per month to make payments on the medical expenses.  In Scenario 2, we make pre-tax HSA contributions that almost cover the HDHP deductible but do not save as much in interest on the loans.  If we incur medical expenses, we don't need to change much at all... we just keep funneling money through the HSA to pay the medical expenses. 

What are your thoughts?  Would you pursue paying the loans first or building the HSA?

I would absolutely kill the student loans first

MDM

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #23 on: September 27, 2015, 12:11:51 PM »
I've attached a much cleaner version of the spreadsheet, including an additional calculation that assumes front-loading of the HSA in both 2016 and 2017.  The sheet also includes a more realistic marginal tax rate that contemplates both state and federal taxes.  And it is now set up in a more flexible way that allows you to more easily change assumptions like investment returns.  There must have been some sort of error in my original sheet because it is now showing that scenario one ($200 to HSA for formula each month, everything else killing student loans) provides the maximum overall wealth at the end of the calculation period. 

Despite the numbers, I still lean toward Hybrid 2 (front-load the HSA in 2016 ASAP, then kill the loans) because it provides a more comfortable emergency fund during the pay-down period.  Before having to replace an air conditioner this summer, we had a $10,000 emergency fund.  $6,500 feels less comfortable.  Hybrid 2 allows us to build our emergency fund back up in a manner that is least detrimental to our long term financial position.  The obvious downside is that the HSA money is restricted to medical expenses unless we pay the additional 10% tax. 

Another reason I still lean toward Hybrid 2 is that we still need to explore refinancing the student loans.  The lower the interest rate on the student loan, the less pronounced the difference between Situation 1 and Hybrid 2.
Your logic seems sound.  Actually seems to be a case in which the lower risk (i.e., having a larger HSA balance) is the same as the higher return (that same HSA balance - whether for the tax-free spending or, when you get a higher balance, the tax-free investment return available).

The spreadsheet has outgrown my ability to do a decent review. :) 
One question, however: why does Hybrid 3 show the highest Total Wealth for Dec-2017, but not for Feb-2018?

MDM

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #24 on: September 27, 2015, 12:17:21 PM »
The first way I could do it would be to submit a W-4 for January, such that I claim lots of exemptions to have maximum access to pre-tax dollars which would then be funneled into the HSA.  Upon maxing out the HSA, I would then need to submit a new W-4 claiming fewer exemptions to increase my withholding in hopes of having no tax owed or refund due at the end of the year. 

This way.

It's ok to owe a little at the end of the year.  Google   tax penalty safe harbor   for some discussion.  Many of the links from that search will emphasize estimated taxes, but the general principle applies to withholding also. 

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #25 on: September 27, 2015, 04:59:18 PM »
One question, however: why does Hybrid 3 show the highest Total Wealth for Dec-2017, but not for Feb-2018?

It is because of front loading the HSA in 2017. The HSA is in a draw-down period during the last months of the calculation period while other scenarios are in post loan payoff investment periods.

MDM

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #26 on: September 27, 2015, 05:43:49 PM »
It is because of front loading the HSA in 2017. The HSA is in a draw-down period during the last months of the calculation period while other scenarios are in post loan payoff investment periods.
To make sure this is really apples vs. apples, it's probably necessary to ensure each option uses the same pre-tax amount each month.  The amounts don't need to be the same from month to month (although they certainly could be, and unless there is a good reason otherwise, probably should be), but they should be the same from option to option across a given month.

The attached shouldn't have any changes in calculations (if it does, mea culpa) but has some additions - that's where the option-to-option differences show up.

Might need to add other "categories" (e.g., taxable and/or tax-advantaged investments), but if so then such is the price of apples vs. apples.

AlwaysLearningToSave

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #27 on: September 28, 2015, 07:56:22 AM »
It is because of front loading the HSA in 2017. The HSA is in a draw-down period during the last months of the calculation period while other scenarios are in post loan payoff investment periods.
To make sure this is really apples vs. apples, it's probably necessary to ensure each option uses the same pre-tax amount each month.  The amounts don't need to be the same from month to month (although they certainly could be, and unless there is a good reason otherwise, probably should be), but they should be the same from option to option across a given month.

The attached shouldn't have any changes in calculations (if it does, mea culpa) but has some additions - that's where the option-to-option differences show up.

Might need to add other "categories" (e.g., taxable and/or tax-advantaged investments), but if so then such is the price of apples vs. apples.

Good thought on how to prove the accuracy of the calculations.  There was an error in your formula for calculating the pre-tax investment each month.  You divided the post tax student loan payment numbers by the marginal tax rate when you should have divided the payment by the difference of one minus the marginal tax rate.  I made the change and everything except for Hybrid 1 proofed out as accurate.  There was an error in Hybrid 1 in which the post-tax student loan payments were too low in from 3/2017 to 9/2017.  See the attached sheet.

Now we know we are comparing apples to apples.


MDM

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #28 on: September 28, 2015, 08:41:31 AM »
Now we know we are comparing apples to apples.
Nice work!

robartsd

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #29 on: September 28, 2015, 08:56:12 AM »
Don't forget that nothing forces you to withdraw from the HSA immediately after incurring the qualified expense. If you pay with other funds but hold on to the documentation, you can delay the HSA withdraw as long as you want.

seattlecyclone

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Re: Kill Student Loans or Build HSA - What Would You Do?
« Reply #30 on: September 28, 2015, 08:58:04 AM »
Don't forget that nothing forces you to withdraw from the HSA immediately after incurring the qualified expense. If you pay with other funds but hold on to the documentation, you can delay the HSA withdraw as long as you want.

While this is certainly true, it doesn't seem like the best option for the OP given that they want to accelerate their student loan payments. Leaving extra money tied up in an HSA runs counter to this goal.