Personal Finance (Not Investing) • Proposed update to Health Savings Account wiki page

You're right; I misread your post. That's what I get for working on a few hours sleep. I still don't think I would agree with your statement though. If someone has an overfunded HSA but has a high marginal tax rate, it could still make sense to contribute to a tIRA (or any pre-tax account)....

In general it "could still make sense" but not given these assumptions:

Of course, if one truly believes an overfunded HSA is likely, and a deductible traditional contribution would end up worse than a taxable contribution, it would be better to avoid the HSA contribution in the first place.

I think I now get what you're saying. You're making a transitive argument - if a deductible tIRA contribution is worse than a taxable contribution, and an overfunded HSA behaves like a deductible tIRA, then you shouldn't contribute to an overfunded HSA. Standard advice is to contribute to an HSA before retirement accounts, and retirement accounts before a taxable account. That's true whether or not the HSA is overfunded. There are exceptions to this order - maybe the most likely being a 401k with terrible fees - but they are not common. If we assume that a deductible traditional IRA contribution is worse than a taxable contribution (unlikely, but let's go with it), and that an HSA is overfunded, I still don't think you can say you shouldn't contribute to an HSA. Over the retirement account, the HSA (1) is payroll tax-deductible, and (2) there is a possibility the HSA will become non-overfunded some day and the money can come out tax-free. Maybe I could contrive a case where one should contribute to taxable before an HSA, but it would be a very rare corner case and not worth mentioning on the wiki. I don't think you're suggesting otherwise.

We can, however, keep the analysis of what to do with any overfunded amount. That applies even without any reference to a non-deductible tIRA. Do you agree?

I'm not sure I agree. The behavior of a non-deductible IRA gives the framework for deciding what investments to put in an overfunded HSA and/or whether to pull money out and reinvest it in taxable.

The amount above qualified medical expenses (i.e., the overfunded amount) will come out as ordinary income. Thus one should compare leaving the money to grow tax free until realizing the ordinary income, vs. realizing the ordinary income and then having annual tax drag but lower tax on future gains.

The underlined phrase may be the root of the disagreement.

Hmm...I thought we have been saying the same thing about that.... For example:

...But if future growth is expected to be taxable, it may make more sense to have that growth in a taxable account instead, where you get lower tax rates on growth, and a step-up in basis.

...looks about the same as the "one should compare leaving..." sentence.

Another way to think about it that might be helpful is that qualified medical expenses create "basis" within the HSA.....

That may be helpful for some, but for most, introducing the concept of basis when it doesn't need to be introduced will not be helpful. Keep it simple: an HSA acts as an HSA when the withdrawals are for qualified medical expenses, and it acts like a tIRA after age 65 for non-qualified withdrawals.

An overfunded HSA does not imply there are no tax-free withdrawals available based on past and current medical expenses. A large HSA without any medical expense available would be rare - someone would need to either have little or no medical expenses (made even less likely because a HSA requires a HDHP), or have withdrawn for all available medical expenses (shrinking the HSA balance). And even if there are no available expenses today, there could be in the future, so you shouldn't treat the HSA as overfunded unless the balance is large. So, in most cases, an overfunded HSA will have a mix of tax-free and taxable dollars. And because withdrawing tax-free before taxable almost always makes sense, the choice being discussed is withdrawing tax-free from an overfunded HSA to reduce the future balance and taxable growth.

Those tax-free dollars behave almost exactly the same as the tax-free dollars in a non-deductible IRA. I called them "basis" because I thought it would help you understand, as I know you're very familiar with retirement accounts. The basis is tax-free, the growth on the basis is taxable. I don't use the term "basis" in the wiki at all. I find semantic arguments pretty weak, so if the comparison helps readers decide whether to withdraw tax-free from an overfunded HSA then it's worth including.

We agree the appropriate comparison for a qualified HSA withdrawal is X dollars in the HSA versus X dollars in taxable. Let me know if you also agree with the following statements:

If the HSA is not overfunded, then by definition all future growth in the HSA will be tax-free. So the choice will be X dollars growing tax-free (ie. in the future, the X dollars in question plus all the growth on those dollars can be withdrawn tax-free) versus X dollars in a taxable account.

Not fully true - see the conversation with AnEngineer about choosing when to take the qualified withdrawals.

That's not what I took out of that conversation. As I explained above, for practical purposes it always makes sense to withdraw tax-free if you are able before taking a taxable withdrawal. Particularly if you have an HSA that you expect to never exceed available medical expenses (which is the definition of a non-overfunded HSA), why would you take a taxable withdrawal?

You, the original owner (or spousal beneficiary) would not take a taxable withdrawal. But you might choose to take a tax-free HSA withdrawal at some point to empty the HSA because you prefer to have your non-charity heirs inherit a stepped-up taxable account instead of the ordinary income incurred with an inherited HSA.

If the HSA is overfunded, then by definition additional future growth in the HSA will be taxable. So the choice will be X dollars growing tax-deferred and taxable as ordinary income when withdrawn (while you retain the right to withdraw the X dollars tax-free later, if you saved receipts) versus X dollars in a taxable account.

Either the X is an overfunded amount or it isn't, unless you have a third definition...?

To be clear, "overfunded" means that the balance is (or reasonably expected to be in the future) greater than available medical expenses, meaning some withdrawals will be taxable.

Yes, no clarification needed.

I suggest thinking about the account as being overfunded or not, rather than a particular set of dollars within the account, because the balance and qualified expenses "stack" next to each other. But an HSA can switch between being overfunded or not, if you get an influx of medical expenses, have good or bad investment performance, or make withdrawals and take contributions.

For the reasons given about basis above, this may help some but not most. I do agree with your note that unforeseen medical expenses, etc., can eliminate the "problem" of an overfunded HSA.

All this said, would you now agree with the two statements you quoted?

If one of the two is the one to which I said, "Yes. I'll go further...." then that reply stands. Remind me of the second?

We agreed on this:

the choice to make a qualified withdrawal of X dollars from an overfunded HSA is equivalent to the choice of leaving X dollars in the HSA, versus investing X dollars in a taxable account.

Then, I asked if you would agree with these two statements:

If the HSA is not overfunded, then by definition all future growth in the HSA will be tax-free. So the choice will be X dollars growing tax-free (ie. in the future, the X dollars in question plus all the growth on those dollars can be withdrawn tax-free) versus X dollars in a taxable account.

If the HSA is overfunded, then by definition additional future growth in the HSA will be taxable. So the choice will be X dollars growing tax-deferred and taxable as ordinary income when withdrawn (while you retain the right to withdraw the X dollars tax-free later, if you saved receipts) versus X dollars in a taxable account.

Given this discussion I'd like to hear whether you agree with those. If it would be helpful to put numbers, we could say the non-overfunded HSA has a balance of $50,000 with $500,000 of current and projected medical expenses. The overfunded HSA has a balance of $500,000 with $50,000 of current and projected medical expenses.

Statistics: Posted by fyre4ce — Sat Jul 27, 2024 12:13 pm — Replies 49 — Views 5435

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