Funding my IRA with an HSA?

[missundecided]

In 2013, I fully funded my HSA and came really close to doing so in 2012 too. Sadly, neither my traditional nor my Roth IRA got the same kind of love. I've been paying my medical expenses out of pocket, but I was thinking that I would withdraw as much as I can now (while still finding that middle ground of keeping enough in my HSA to meet my deductible and other medical expenses that aren't covered by insurance) and placing it into one of my IRAs. I haven't tallied them all up, but the to-be-distributed money may be in the high $100s or just a bit over $1000. Obviously, nowhere close to closing the gap on my IRA limit, but every little bit helps, right?

I can and do invest money within my HSA account, but only $30/month; the mutual funds available (I have the HSA with Health Equity) have higher expense ratios than say, Vanguard, and as previously mentioned, I want to keep the HSA balance at a decent level so I try not to lose too much of the "seed money." Currently, I have a little over $3000 in my HSA. Deductible is $2500 but I have orthodontia expenses coming up that will eat into it a little more too. I plan on fully funding the HSA again this year.

At $40k gross, after my 5% 401k contribution (where the company match ends) and other pre-tax deductions, I'm firmly in the 15%, which makes me wonder if instead of feeding the HSA into my Roth, I feed my traditional instead. I have read a lot about people doing a Roth conversion, but it seems like the only people who do so have a higher bracket, and I can't help but wonder if I should do the same while I still am in the 15%. (Though, to be honest, I don't know that I'll ever get into a higher bracket.) Would converting HSA into traditional into Roth be much more trouble than it's worth?

For what it is worth, I am in California, a state that does not recognize the tax shelter of HSAs. However, from my understanding, to make up for this, withdrawals from an HSA account get some kind of tax benefit, but I'm not yet clear on how this works.

Other information that might be helpful: I have a student loan at 5.12 at just a smidge over $7000. If there are other details I can provide, happy to do so. I welcome your opinions!

[tdccarpenter]

To me it really depends.  If your HSA can be rolled form year to year an goes with you when you leave, I would leave the money in the HSA.  You will eventually need the money for medical expenses.  As for the student loan, make required minimium payments, you pay less than 2500 in interest so you get any interest paid back on the tax return.

[sherr]

If your HSA can be rolled form year to year an goes with you when you leave...

All HSAs do, by definition. If it doesn't then it's not an HSA, it's a Medical or Flex Spending Account .

For what it is worth, I am in California, a state that does not recognize the tax shelter of HSAs. However, from my understanding, to make up for this, withdrawals from an HSA account get some kind of tax benefit, but I'm not yet clear on how this works.

I didn't realize there were such states. :(
According to http://www.benefitscafe.com/articles/taxtreatment.html you're right, so money you contribute to your HSA will not be taxed federally but will be taxed locally. I would expect that to change in a few years as California's laws catch up, but for now that's the state of things. I can't comment on any tax benefits of withdrawals, as I don't know anything about it and the article doesn't mention anything. That being said that's not the end of the world though; federal taxes are probably still the vast majority of you tax bill even in California, right?

HSAs have a benefit (federally) that says you can withdraw money for any reason after you've reached retirement age and not have to pay the penalty. That means that HSAs really *are* traditional IRAs, they just have the additional benefits of not counting towards your IRA contribution limit and being able to use the money tax-free for medical expenses. As such if you were asking about withdrawing the money from your HSA and contributing to a traditional IRA the answer would be an easy "no", you should leave it in the HSA where you get all benefits of the IRA plus some extra.

Given that you're in the 15% tax bracket though you're probably right, Roth IRAs are probably a better deal for you than traditional IRAs. However, I still think withdrawing from your HSA to fund a Roth IRA is a bad idea, because you'd have to pay a 10% penalty on top of the normal income taxes for the non-qualified withdrawal. Instead I would suggest that you start using your HSA for actually paying your medical bills (since that way that money is completely tax-free), and ramp up contributing to your Roth IRA instead of continuing to contribute extra to your HSA (assuming you can only do one).

[missundecided]

To clarify, all potential withdrawals from the HSA would be qualified distributions, as I would be paying myself back for the medical bills I've been paying out of pocket already. I wouldn't dream of pulling anything with penalty fees attached.

[sherr]

To clarify, all potential withdrawals from the HSA would be qualified distributions, as I would be paying myself back for the medical bills I've been paying out of pocket already. I wouldn't dream of pulling anything with penalty fees attached.

Ah. Well then yes, I would say do that. Paying for something tax-free is always better than paying for something with after-tax dollars, no? And then sure, you could contribute the money that you newly-have-not-spent on out-of-pocket medical expenses to your Roth IRA. (I hope that's not too confusing, all I really mean is that you can contribute the reimbursed funds to your Roth).