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.