Author Topic: Medical Expense. Use cash or HSA?  (Read 6929 times)

EngiNerd

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Medical Expense. Use cash or HSA?
« on: January 22, 2016, 06:33:21 PM »
What are the pros and cons of using cash to pay for a medical expense vs using funds from an HSA.  I have always used cash thinking I should try to maximize tax protected investment accounts.  However, in a discussion with a coworker he mentioned that due to inflation it may be optimal to save taxes on $x today vs saving taxes on $x 20 or 30 years from now, especially if you are in a lower tax bracket due to early retirement.  Plus you wouldn't have to keep up receipts and etc.  This was one of those areas that I'm not sure there is a consensus answer to from the early retirement community, and maybe it depends more on the specific RE plan.  For instance, for the person that wants to retire extremely early and achieve the lowest possible tax bracket it might not be superior to pay cash and defer tax savings until later.  But maybe to another who doesn't mind working 25 years and just likes living and managing finances efficiently as possible it might be good to let that tax protected account grow and have receipts for tax free withdrawals in the future.  What say you MMM community? 

sol

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Re: Medical Expense. Use cash or HSA?
« Reply #1 on: January 22, 2016, 06:42:04 PM »
Generally speaking, use cash.  There are rare circumstances where this isn't the best choice.




LAGuy

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Re: Medical Expense. Use cash or HSA?
« Reply #2 on: January 22, 2016, 10:37:14 PM »
Generally speaking, use cash.  There are rare circumstances where this isn't the best choice.

I myself am on an HSA plan this year for the first time. From a min/max perspective this seems to be the correct choice. But I'm not sure if I want to be dealing with the receipts for the next 30 years. Especially on ticky tack doctors office visits and the like. For myself, while not optimal, I'm thinking I will go ahead and use the HSA funds to cover my medical expenses unless it's something major involving a large bill.

sol

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Re: Medical Expense. Use cash or HSA?
« Reply #3 on: January 22, 2016, 10:45:41 PM »
I myself am on an HSA plan this year for the first time. From a min/max perspective this seems to be the correct choice. But I'm not sure if I want to be dealing with the receipts for the next 30 years.

Why are you dealing with receipts if you're using cash instead of HSA funds to pay for your medical expenses?

We just pay cash.  The HSA becomes just another tax-advantaged savings account that I'm trying to max every year, and spending it down would just mean I would lose that tax advantaged space.  I don't spend out of my Roth IRA, either, even though I could technically withdraw all of my contributions without paying any taxes or penalties.  I want all of that money sheltered for as long as possible.

MDM

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Re: Medical Expense. Use cash or HSA?
« Reply #4 on: January 22, 2016, 10:58:22 PM »
What are the pros and cons of using cash to pay for a medical expense vs using funds from an HSA.  I have always used cash thinking I should try to maximize tax protected investment accounts.  However, in a discussion with a coworker he mentioned that due to inflation it may be optimal to save taxes on $x today vs saving taxes on $x 20 or 30 years from now, especially if you are in a lower tax bracket due to early retirement.  Plus you wouldn't have to keep up receipts and etc.  This was one of those areas that I'm not sure there is a consensus answer to from the early retirement community, and maybe it depends more on the specific RE plan.  For instance, for the person that wants to retire extremely early and achieve the lowest possible tax bracket it might not be superior to pay cash and defer tax savings until later.  But maybe to another who doesn't mind working 25 years and just likes living and managing finances efficiently as possible it might be good to let that tax protected account grow and have receipts for tax free withdrawals in the future.  What say you MMM community?
Let's say you have $1000 in your checking account, $1000 in your HSA, and you have a $1000 medical bill due now.  You have a choice between
A) paying the bill from checking and leaving the $1000 invested in the HSA
B) paying the bill from the HSA and moving the $1000 from checking into your no-load, low fee Fidelity/Schwab/Vanguard/etc. investment

To evaluate the choices you have to know the expected investment return from each and the tax treatment of option B.

Your after-tax value after "n" years in the taxable account can be calculated as follows.
cgt = capital gain tax rate, %
d = annual dividend rate, %
e = effective annual growth, accounting for tax drag on dividends, %
ecgt = effective capital gain tax rate, accounting for increased basis due to reinvested dividends, %
F = Future, after tax, value of invested principal
g = annual growth excluding dividends, %
n = years invested, yr
P = principal invested, $
t = tax rate on dividends, %

e = g + d * (1 - t)
ecgt = cgt * g / e

F = P * ((1 + e)^n * (1 - ecgt) + ecgt)

If your expected returns are identical (e.g., you get a no cost HSA with Fidelity) the HSA grows to F = P * (1 + g + d)^n because there is no tax on gains or withdrawals.

Back to the taxable account, let cgt = 15%, d = 2%, g = 5%, n = 30, P = $1000, t = 15%.
  e = 5% + 2% * (1 - 15%) = 6.7%
  ecgt = 15% * 5% / 6.7% = 11.2%
  F = $1000 * (1.067^30 * (1 - 0.112) + .112) = $6,326

For the HSA
  F = $1000 * (1.07)^30 = $7,612

The choice is yours....  Of course, your tax numbers may be different. 

ETA: And the expected return in the HSA may be worse than in taxable if you don't have a good HSA provider.  Need to check for your individual situation.
« Last Edit: January 22, 2016, 11:02:35 PM by MDM »

MoonShadow

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Re: Medical Expense. Use cash or HSA?
« Reply #5 on: January 22, 2016, 11:08:51 PM »
There is another choice, if you don't have enough income to max out both the HSA and a Roth IRA.  You could pay cash, then withdraw that amount from your HSA and deposit it into the Roth IRA.  This *should* have the same mathmatical effect as keeping it inside the HSA, with a decent investment, and withdrawing it in retirement for either medical expenses at that time or keeping your cash receipts (or digital version of same, my HSA provider tracks what I *should* have paid out of it).

whodidntante

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Re: Medical Expense. Use cash or HSA?
« Reply #6 on: January 22, 2016, 11:38:50 PM »
I use cash.  My HSA is an IRA for me.  If you are currently maxing out your tax advantaged retirement accounts, you should consider using cash too, IMO. 

SomedayStache

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Re: Medical Expense. Use cash or HSA?
« Reply #7 on: January 23, 2016, 06:57:46 AM »



Why are you dealing with receipts if you're using cash instead of HSA funds to pay for your medical expenses?

We just pay cash.  The HSA becomes just another tax-advantaged savings account that I'm trying to max every year, and spending it down would just mean I would lose that tax advantaged space.  I don't spend out of my Roth IRA, either, even though I could technically withdraw all of my contributions without paying any taxes or penalties.  I want all of that money sheltered for as long as possible.

I've only been an hsa holder for 20ish days, so I'm no expert.  I think the plan for folks to retain receipts for decades is that medical expenses are the only tax free way to withdraw money from your hsa.  So if you save all medical receipts for thirty years and have an accumulated total of $15,000 of medical expenses then you can withdraw that tax free.
Whereas if you just treat it as an ira you will be taxed on it in old age retirement (no penalties, but your ordinary tax rate-but maybe you intend on having no tax liability in retirement anyway and this is moot).

One idea I like is to pay cash for medical expenses, save receipts, and treat the hsa as part of your emergency fund.  Since you can only withdraw up to the amount of medical receipts you have this has limited use.  But after enough years of owning the hsa the tax free amount accessible to you could be substantial.

GrOW

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Re: Medical Expense. Use cash or HSA?
« Reply #8 on: January 23, 2016, 07:12:03 AM »
I myself am on an HSA plan this year for the first time. From a min/max perspective this seems to be the correct choice. But I'm not sure if I want to be dealing with the receipts for the next 30 years.

Why are you dealing with receipts if you're using cash instead of HSA funds to pay for your medical expenses?

I bet he is talking about having receipts for future, maybe way in the future, hsa withdrawal documentation.

A few HSA providers are trying to tackle this challenge but utilizing a receipt upload feature very similar to one used for FSA and HRA substantiation with the twist the the receipt capture is for your future use. You upload your receipts after paying for an eligible expense with cash, the data is stored and you can give it a custom name to help you remember what it is years from now, you can see you building "available tax free withdrawal amount", and when you are ready to take a tax free withdrawal you can select a matching amount of receipts and print them out again this time for you upcoming tax reporting needs. Now I don't think that I would trust that to be my only receipt storage since if they have a meltdown or go out of business you may lose your stored receipts.....but it is a very interesting feature that more HSA admins are offering.

BlueMR2

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Re: Medical Expense. Use cash or HSA?
« Reply #9 on: January 23, 2016, 07:46:46 AM »
I use the HSA.  To me the HSA is just a way to be able to pay for healthcare pre-tax.  I don't max it out either, going in at half the max as that more than covers even my worst years.

In my case, I'm already very heavily loaded into the retirement accounts and am a bit cash poor.

Fire2025

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Re: Medical Expense. Use cash or HSA?
« Reply #10 on: January 23, 2016, 08:24:55 AM »
I use the HSA.  To me the HSA is just a way to be able to pay for healthcare pre-tax.  I don't max it out either, going in at half the max as that more than covers even my worst years.

In my case, I'm already very heavily loaded into the retirement accounts and am a bit cash poor.
This is similar to my situation.  I don't earn enough to max out everything and still have cash.  So I'm maxing out my 401k, Roth, and funding HSA to half the max. 

I think of my HSA as a medical emergency fund.  If I can afford cash, for the small stuff, I will pay cash, but I know I will often need to use the monies, in the HSA, for medical expenses.

Also I can't manage my own HSA, it's through work and they manage it, so I'm not assuming it will have much growth for the next 10 years, which is my FIRE window.

ender

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Re: Medical Expense. Use cash or HSA?
« Reply #11 on: January 23, 2016, 08:36:48 AM »
I use the HSA.  To me the HSA is just a way to be able to pay for healthcare pre-tax.  I don't max it out either, going in at half the max as that more than covers even my worst years.

In my case, I'm already very heavily loaded into the retirement accounts and am a bit cash poor.

Keep in mind that when you have an employer HSA you don't pay FICA on your contributions, so if you have control over what your HSA is invested in you get an additional 7.5% tax savings putting money into it vs a 401k.

Depending on your income too it might be helpful as it further reduces your income for IRA deduction limits.

Paul der Krake

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Re: Medical Expense. Use cash or HSA?
« Reply #12 on: January 23, 2016, 08:50:26 AM »
I pay cash, and plan on reimbursing myself in my Roth conversion years, when keeping taxable income low is key.

EngiNerd

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Re: Medical Expense. Use cash or HSA?
« Reply #13 on: January 23, 2016, 10:04:53 AM »
I myself am on an HSA plan this year for the first time. From a min/max perspective this seems to be the correct choice. But I'm not sure if I want to be dealing with the receipts for the next 30 years.

Why are you dealing with receipts if you're using cash instead of HSA funds to pay for your medical expenses?

We just pay cash.  The HSA becomes just another tax-advantaged savings account that I'm trying to max every year, and spending it down would just mean I would lose that tax advantaged space.  I don't spend out of my Roth IRA, either, even though I could technically withdraw all of my contributions without paying any taxes or penalties.  I want all of that money sheltered for as long as possible.

As others have mentioned.  If you have a receipt for a qualifying medical expense you can withdraw money tax free.  Like contributing to pre tax ira it lowers you're current tax expense but in the future you can withdraw money without paying taxes like a roth ira. 

What are the pros and cons of using cash to pay for a medical expense vs using funds from an HSA.  I have always used cash thinking I should try to maximize tax protected investment accounts.  However, in a discussion with a coworker he mentioned that due to inflation it may be optimal to save taxes on $x today vs saving taxes on $x 20 or 30 years from now, especially if you are in a lower tax bracket due to early retirement.  Plus you wouldn't have to keep up receipts and etc.  This was one of those areas that I'm not sure there is a consensus answer to from the early retirement community, and maybe it depends more on the specific RE plan.  For instance, for the person that wants to retire extremely early and achieve the lowest possible tax bracket it might not be superior to pay cash and defer tax savings until later.  But maybe to another who doesn't mind working 25 years and just likes living and managing finances efficiently as possible it might be good to let that tax protected account grow and have receipts for tax free withdrawals in the future.  What say you MMM community?
Let's say you have $1000 in your checking account, $1000 in your HSA, and you have a $1000 medical bill due now.  You have a choice between
A) paying the bill from checking and leaving the $1000 invested in the HSA
B) paying the bill from the HSA and moving the $1000 from checking into your no-load, low fee Fidelity/Schwab/Vanguard/etc. investment

To evaluate the choices you have to know the expected investment return from each and the tax treatment of option B.

Your after-tax value after "n" years in the taxable account can be calculated as follows.
cgt = capital gain tax rate, %
d = annual dividend rate, %
e = effective annual growth, accounting for tax drag on dividends, %
ecgt = effective capital gain tax rate, accounting for increased basis due to reinvested dividends, %
F = Future, after tax, value of invested principal
g = annual growth excluding dividends, %
n = years invested, yr
P = principal invested, $
t = tax rate on dividends, %

e = g + d * (1 - t)
ecgt = cgt * g / e

F = P * ((1 + e)^n * (1 - ecgt) + ecgt)

If your expected returns are identical (e.g., you get a no cost HSA with Fidelity) the HSA grows to F = P * (1 + g + d)^n because there is no tax on gains or withdrawals.

Back to the taxable account, let cgt = 15%, d = 2%, g = 5%, n = 30, P = $1000, t = 15%.
  e = 5% + 2% * (1 - 15%) = 6.7%
  ecgt = 15% * 5% / 6.7% = 11.2%
  F = $1000 * (1.067^30 * (1 - 0.112) + .112) = $6,326

For the HSA
  F = $1000 * (1.07)^30 = $7,612

The choice is yours....  Of course, your tax numbers may be different. 

ETA: And the expected return in the HSA may be worse than in taxable if you don't have a good HSA provider.  Need to check for your individual situation.


I think you too are missing the main tax benefit an HSA.  $1000 cash is not equal to $1000 (pre-tax) in an HSA.  Say you are in the 25%  tax bracket, that $1000 dollars in your HSA is like $750 cash.  Or say you're in the 25% tax bracket when you retire when you pull out your $7,612 to fund a vacation or whatever wouldn't it only be worth $5,709?   Or say you saved your $1000 receipt would it be:
.75*6612+1000 =$ 5,959.   

I'm not sure if I am over complicating things but I suspect that optimal use depends on current tax bracket vs future retired tax bracket.  Saving on taxes while earning in a high tax bracket and then paying capital gains taxes on after tax investments may be (really not sure) superior to saving on taxes after retirement if you are in a low tax bracket.  At least that's what I expect.  Plus you don't have to keep track of receipts for 20 to 30 years.   
« Last Edit: January 23, 2016, 11:34:18 AM by EngiNerd »

MDM

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Re: Medical Expense. Use cash or HSA?
« Reply #14 on: January 23, 2016, 11:41:58 AM »
I think you too are missing the main tax benefit an HSA.  $1000 cash is not equal to $1000 (pre-tax) in an HSA.
It is equivalent if you want to pay a $1000 medical bill today.  Either the cash or the HSA funds will pay exactly $1000 and satisfy the medical bill. 

Quote
Say you are in the 25%  tax bracket, that $1000 dollars in your HSA is like $750 cash.  Or say you're in the 25% tax bracket when you retire when you pull out your $7,612 to fund a vacation or whatever wouldn't it only be worth $5,709?
Sure, if you don't use the HSA for medical bills then you lose the tax advantage on withdrawal and the HSA behaves the same as a tIRA.  One can choose what to assume about the medical costs one will incur over one's life....   

Quote
I'm not sure if I am over complicating things but I suspect that optimal use depends on current tax bracket vs future retired tax bracket.  Saving on taxes on a while earning in a high tax bracket and then paying capital gains taxes on after tax investments may be (really not sure) beneficial to saving on taxes after retirement if you are in a low tax bracket.  At least that's what I expect.
This is (or is at least similar to) the Traditional vs. Roth discussion.  A worthy topic in its own right, but different from HSA (in which no taxes are ever paid) vs. Something Else.

Quote
Plus you don't have to keep track of receipts for 20 to 30 years.
True.  Different people will assign different costs to this activity.

MoonShadow

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Re: Medical Expense. Use cash or HSA?
« Reply #15 on: January 23, 2016, 12:21:32 PM »



Why are you dealing with receipts if you're using cash instead of HSA funds to pay for your medical expenses?

We just pay cash.  The HSA becomes just another tax-advantaged savings account that I'm trying to max every year, and spending it down would just mean I would lose that tax advantaged space.  I don't spend out of my Roth IRA, either, even though I could technically withdraw all of my contributions without paying any taxes or penalties.  I want all of that money sheltered for as long as possible.

I've only been an hsa holder for 20ish days, so I'm no expert.  I think the plan for folks to retain receipts for decades is that medical expenses are the only tax free way to withdraw money from your hsa.  So if you save all medical receipts for thirty years and have an accumulated total of $15,000 of medical expenses then you can withdraw that tax free.
Whereas if you just treat it as an ira you will be taxed on it in old age retirement (no penalties, but your ordinary tax rate-but maybe you intend on having no tax liability in retirement anyway and this is moot).

Most people will be able to withdraw most or all of their HSA funds tax free in retirement, anyway, since the average married couple spends over $200K from age 65 to death, and that is with medicare coverage.  If you don't want to worry about receipts, don't worry about receipts.  The HSA still makes for a better retirement account than an IRA.

EngiNerd

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Re: Medical Expense. Use cash or HSA?
« Reply #16 on: January 23, 2016, 05:59:34 PM »
I didn't realize that.  If that is true it definitely simplifies the issue.  I was thinking about using part of it as another tax advantage investing device to fund early retirement.  I am skeptical that two spouses they're ira out and investing with little to no fees will need the complete balance of the HSA(s).

                                                                                                                                                                             

Most people will be able to withdraw most or all of their HSA funds tax free in retirement, anyway, since the average married couple spends over $200K from age 65 to death, and that is with medicare coverage.  If you don't want to worry about receipts, don't worry about receipts.  The HSA still makes for a better retirement account than an IRA.


This is (or is at least similar to) the Traditional vs. Roth discussion.  A worthy topic in its own right, but different from HSA (in which no taxes are ever paid) vs. Something Else.

« Last Edit: January 23, 2016, 06:14:53 PM by EngiNerd »

v8rx7guy

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Re: Medical Expense. Use cash or HSA?
« Reply #17 on: January 23, 2016, 11:11:04 PM »
I am setting aside funds in my HSA for medical expenses, and plan on using these funds whenever qualifying expenses come up.  My hope is that my HSA will eventually grow to the point where I have enough to cover my family max OOP. Hopefully I will also be able to pay for my kids futute orthodontics bills

BlueMR2

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Re: Medical Expense. Use cash or HSA?
« Reply #18 on: January 24, 2016, 07:06:27 AM »
Keep in mind that when you have an employer HSA you don't pay FICA on your contributions, so if you have control over what your HSA is invested in you get an additional 7.5% tax savings putting money into it vs a 401k.

Depending on your income too it might be helpful as it further reduces your income for IRA deduction limits.

Not great options available, but there are 3 halfway decent Vanguard funds my HSA is invested in.

Yeah, our combined income is around half what most of the forum seem to be making, so I don't have those issues.  :-)  (the last few years my wife and I put together made less than I made by myself back in the good ol' days of the early 2000's)

seattlecyclone

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Re: Medical Expense. Use cash or HSA?
« Reply #19 on: January 24, 2016, 12:12:57 PM »
Depending on your income and other tax-advantaged savings options, there are two basic strategies that make sense for spending your HSA funds.

1) If you can't afford to max out all of your tax-sheltered savings accounts, withdraw any medical expenses from your HSA each year. Take the cash you could have spent on medical expenses and contribute it to your IRA or 401(k).
2) If you are already maxing out all of your tax-sheltered savings accounts, pay cash for medical bills. Save your receipts. Let the HSA money compound until you retire.

Whichever strategy applies to you, you should max out your HSA right after maximizing your 401(k) match because the tax benefits are greater than other accounts that you could contribute to instead. You won't pay tax on this money on the way in or out. You can't beat that! If you never have enough medical bills to exhaust your HSA funds, that's such a great problem to have. Even there, the account is roughly equivalent to a traditional IRA once you hit 65.

A well-funded HSA, combined with a stack of receipts from past medical expenses that haven't been reimbursed yet, can be a great tool for an early retiree now that the ACA exists. You might target an income just under 200% of the federal poverty level to get a really nice silver plan with cost-sharing benefits. If you get toward the end of the year, your income is really close to your goal already and you're worried about going over, you can use the HSA as a nice backup plan for withdrawing a bit of money tax-free to keep your income where you want it.
« Last Edit: January 24, 2016, 12:15:37 PM by seattlecyclone »