Tax benefits of the HSA
I often hear the HSA touted as having a "triple tax advantage". No income tax on the money you put in, no capital gains tax if you invest money within the HSA, and no income tax when you take money out (AFTER age 65 for specific types of expenses that are eligible ( = to pay for healthcare )).
I am a bit skeptical of this. For one, you have to keep your receipts for eligible expenses (for decades, perhaps!) to be allowed to get the amount of money out tax free. I think most people aren't extremely organized, so are they really going to be able to store that $120 dentist payment receipt from 2025 somewhere safe until say 2055 when they can finally use it to get money out of the HSA?
Second I think the gains are slightly exaggerated because you still need to pay that 2025 dentist bill. If you don't pay it from your HSA with pretax dollars (as you are allowed to do but choose not to do), you will now pay it with posttax dollars - for the "gain" of being able to get pretax dollars out of the HSA many years from now. So you're just postponing one tax benefit if you're not using HSA dollars now, you're not really gaining an extra tax benefit.
Third, when I ran some numbers I found that it is easily possible that your HSA balance grows to something way larger than whatever medical bills you have been able to accumulate. (And let's hope so, too!). So then after age 65 some of it can be taken out tax-free, but you may have a large amount that can't be taken out without paying income tax. In this way, it could function similar to a traditional 401k or so. I guess that's still nice, but not a triple tax benefit.
So in my opinion, the HSA is pretty nice, but not extremely beneficial...
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I often hear the HSA touted as having a triple tax advantage.
You missed a potential 4th tax advantage of HSAs. If you make an HSA contribution through employer payroll deduction, the deduction is exempt from FICA.
No income tax on the money you put in, no capital gains tax if you invest money within the HSA, and no income tax when you take money out AFTER age 65 for specific types of expenses that are eligible to pay for healthcare .
Capital gains are not a thing in any tax advantaged account. You can also invest in bonds, which throw off interest and you don't even mention dividends. None of these things are taxable within an HSA.
You are completely wrong about tax free distributions. You can take a distribution at any time if you have incurred a qualifying medical expenses after you first opened and funded your HSA. You don't have to be 65 or older. Whomever told you that is just WRONG.
This means if you want, you can just contribute the funds you need to pay for qualifying expenses as you incur them. This lets you avoid income taxes and possibly FICA on those expenses. This is the MINIMUM utility of a HSA. Investing excess savings is a stretch goal.
The age 65 only comes into play if you take a non-qualifying distribution from the HSA. This lets you avoid paying the early withdrawal penalty, but you still owe ordinary income taxes on the distribution. This option lets you treat any balance remaining in the HSA like you would a Traditional IRA account - just not until you turn 65.
I happen to think HSAs are great. I'm 60 and I have about $125K in an HSA. The account is invested in 80% VTI, 10% BND and 10% SCHP. I've contributed maybe $50-60K.
you have to keep your receipts for eligible expenses for decades
No, you don't. You can take the distributions as you incur the expenses. Or if you retire early, you might want to use them to help you keep your ACA MAGI low to maximize your ACA premium tax credits.
Regardless, most of your qualifying expenses are going to be run through your insurance. Your insurance will let you download EOBs and often a spreadsheet listing all of your expenses for the year. You can store this information in the cloud. I use the One Drive storage that comes with my Microsoft account.
Second I think the gains are slightly exaggerated because you still need to pay that 2025 dentist bill.
If you think of your dentist bill as letting you make an additional tax free contribution to your Roth IRA, would that help you justify it? The growth is real. I made my first HSA contribution almost 18 years ago. I've never taken a distribution. All total, I've contributed around $50-60K, but the balance is about $125K.
Third, when I ran some numbers I found that it is easily possible that your HSA balance grows to something way larger than whatever medical bills you have been able to accumulate.
You're not wrong there. Contributing too much could be a problem. There is also the issue that HSA accounts make for a bad inheritance vehicle. This means you need to start spending them down as soon as you can after you retire.
But it may be possible to spend them down. You aren't considering that COBRA, Medicare and Medicare Advantage premiums as well as IRMAA are all HSA eligible expenses. Also Medicare doesn't give you completely free medical care. There are deductibles, copays and a maximum out of pocket to cover. All of these expenses are also HSA eligible expenses.
And then there are any medically necessary long-term care and final medical expenses. These can all be used to deplete your HSA before you die. Just don't let the HSA accumulate so much that the balance will grow faster than you could possibly spend it down. If you get to the point where you think you have too much, you should plan on drawing it down before you start drawing from your pre-tax accounts.
This was very helpful, as this is my first year contributing to and maxing out an HSA. Thank you
I disagree and agree.
Medicare premiums are expensive and will just continue to rise. $2200/person/yr for base Part B and $8K/person/yr (B+D) if you are in the next to highest IRMAA bracket. Health care costs not covered by insurance are also likely to be high post-Medicare.
The marketing of HSAs as triple tax-free is BS. There are only two pots of money 1) the initial investment and 2) the gains. To claim "triple", one has to separate the tax on the gains into 1) what would be taxed before withdrawal and 2) what would be taxed after withdrawal. It's a bogus distinction as both are taxed as regular income not capital gains if they are not used for covered health care costs. The gains would never be taxed twice!
That's another nice way to look at it.
So you do think that you will probably have enough qualifying (or eligible) healthcare costs to take the money out without having to pay income tax on it, but you feel like it's not a triple tax benefit but maybe a dual one (if taken out for qualifying expenses, then no income tax on the original invested money and no taxes on the capital gains).
By the way, in my calculations (assuming a couple who put in the max), I had about 450k of money in the HSA at age 65. I assumed they would have accumulated receipts for 250k of eligible healthcare costs by that age, leaving 200k. Do you really think that you will be spending the 200k on healthcare in the next 2-3 decades, when you assume that you will also still keep some of the money invested and that it will grow some more?