Using HSA Reimbursements to keep taxes low during Roth conversion years

[DadJokes]

I began keeping up with medical receipts for unreimbursed medical expenses late in 2019. In the two years since then, I've incurred roughly $5,000 in unreimbursed expenses. Assuming that I maintain that rate of expenditures for the next decade, I would have $30k or so available for reimbursement, completely tax-free.

Granted, $30k is a fairly small amount (roughly six months' expenses for us), but that could make taxes a little bit easier when doing Roth conversions while also living off other investments.

Is that the best use of the unreimbursed HSA money? Up to this point, I've basically just considered it a backup emergency fund.

[secondcor521]

There's a set of tradeoffs to consider.

You're right in that it is a source of tax-free cash flow, so you could live on it for a bit while doing Roth conversions.  It could be considered part of the "5 years of expenses" priming the pump fund.

On the other hand, taking money out of the HSA takes the money out of a tax-free growth vehicle.  If the HSA is invested, it could grow even more if you left it in longer.  Maybe you would have $60K available if you left it another 7-10 years in the HSA.

On the other other hand, HSAs are taxed pretty poorly if you die with one, and they are another account to keep track of.  So getting rid of it avoids poor taxation and simplifies account management.

I'm 52 and single.  My plan is to contribute the annual max, leave mine invested and growing until some time in my early sixties, then drain it aggressively until it's empty.  At age 65 mine is projected to be about three years expenses.

[Paul der Krake]

Yes, it's a great use of delayed reimbursement.

[ixtap]

It is a good use of the HSA, but you just won't know until the time comes what are the best options for your various accounts.

[DadJokes]

There's a set of tradeoffs to consider.

You're right in that it is a source of tax-free cash flow, so you could live on it for a bit while doing Roth conversions.  It could be considered part of the "5 years of expenses" priming the pump fund.

On the other hand, taking money out of the HSA takes the money out of a tax-free growth vehicle.  If the HSA is invested, it could grow even more if you left it in longer.  Maybe you would have $60K available if you left it another 7-10 years in the HSA.

On the other other hand, HSAs are taxed pretty poorly if you die with one, and they are another account to keep track of.  So getting rid of it avoids poor taxation and simplifies account management.

I'm 52 and single.  My plan is to contribute the annual max, leave mine invested and growing until some time in my early sixties, then drain it aggressively until it's empty.  At age 65 mine is projected to be about three years expenses.

If I’m only generating $2,500 in reimbursable expenses annually but contributing $7k, that still leaves a lot of money to grow. However, I agree that it’s a tradeoff. If the total in reimbursable money is the $30k, that would be worth $140k 20 years later if left alone. Who knows, that might be very useful to pay for medical expenses in my 60s. I’d like to think that we’ll have a better system by then, but probably not.

[JoePublic3.14]

It is a good use of the HSA, but you just won't know until the time comes what are the best options for your various accounts.

And then of course it won’t be until years after that that you’ll know if best was best.

Great ti have that option for sure.

[terran]

I would consider unreimbursed HSA balances nearly, but not quite as good to have as Roth contributions. The reason I say not quite as good is because 1) growth on the unreimbursed amount is only tax free if used for medical expenses and 2) if you die before reimbursing yourself and someone other than your spouse inherits they'll owe taxes on the full HSA balance unless they know about the unreimbursed medical expenses. As such, I would withdraw unreimbursed HSA balances before Roth contributions during retirement, but after spending down taxable. Unless you just don't want to continue to track the receipts, in which case reimbursing yourself sooner would be reasonable. 

[PhrugalPhan]

Using HSA money to keep expenses (& income) low to allow more Roth conversions is, in my mind, the perfect thing to do with an HSA (and it is my plan).  You will be taking money that is allowed to grow tax free (but limited tax free withdrawals - medical only) and by paying taxes on the conversion of (say 401k) money to Roth IRA money, you are effectively converting HSA money to Roth money.  Now that money can still grow tax free, but it removes the limitations on tax free withdrawals.  Now this only helps you if you were low on cash to make the Roth conversions in the first place.  If you had money sitting around to pay the taxes on the conversion (making that money now tax free), you are losing the tax free growth of the money pulled from the HSA.

In my case I have so much 457b pre-tax money I want to convert I doubt I will have enough to pay the taxes, so the HSA will be my backstop in case I am short of money in the Roth conversion years.