HSA: Pay for Expenses Now or Later?

To save your HSA money for the future or spend it for medical expenses? Let’s look at two common ways to handle your HSA account and decide which one is the best avenue for you.

Recently, a reader named Charlie left this comment on Stealth IRA: Health Savings Account:

“I love how this is written assuming no large medical expenses. Have kids 🙂 You’ll eat through most, if not all of your HSA contributions every year. I know I have for the last two years.

I’m glad I can pay our medical expenses with pre-tax dollars, but I no longer consider my HSA account as a stealth IRA.”

It brings up a great question: Should I use my HSA to pay for out-of-pocket health care expenses today or should I instead pay for out-of-pocket health care expenses with current cash flow and let the HSA money compound and grow?

Those of us with a Health Savings Account (like Charlie) know that it’s an excellent account. If you use the HSA money for health care expenses, it’s triple-tax-advantaged. The money isn’t (i) taxed when contributed; (ii) taxed as it grows; or (iii) taxed when used, if spent on a qualified medical expense. That makes it better than a Traditional IRA, Roth IRA, 401(k) or 529 accounts.

The Health Savings Account is such a good deal that money should be contributed to an HSA in preference to any other retirement account except for contributions matched by your employer.

Even if you end up with perfect health or never have any medical expenses, after you reach age 65 you can withdraw money from a Health Savings Account in the same way as a Traditional IRA and use the funds for whatever purpose you want, such as covering living expenses or a trip to Paris. In other words, the best case health scenario means at worst the HSA is another Traditional IRA.

Two schools of thought on using HSA money

So, we’ve established that the Health Savings Account is a must-have if you have a high-deductible health insurance plan. But, how should you use it?

There are primarily two camps: (1) Use the HSA money to cover current out-of-pocket expenses; or (2) Use cashflow to cover current out-of-pocket costs, save the receipts for future reimbursement and let the money grow in the HSA.

Requesting reimbursement for healthcare expenses 30-40 years after you originally incurred the expense is allowed. There’s no requirement that you claim HSA reimbursements during the same calendar year you incur the expense. This issue came up specifically in IRS Notice 2005-40 (emphasis mine):

Q-39. When must a distribution from an HSA be taken to pay or reimburse, on a tax-free basis, qualified medical expenses incurred in the current year?

A-39. An account beneficiary may defer to later taxable years distributions from HSAs to pay or reimburse qualified medical expenses incurred in the current year as long as the expenses were incurred after the HSA was established. Similarly, a distribution from an HSA in the current year can be used to pay or reimburse expenses incurred in any prior year as long as the expenses were incurred after the HSA was established. Thus, there is no time limit on when the distribution must occur. However, to be excludable from the account beneficiary’s gross income, he or she must keep records sufficient to later show that the distributions were exclusively to pay or reimburse qualified medical expenses, that the qualified medical expenses have not been previously paid or reimbursed from another source and that the medical expenses have not been taken as an itemized deduction in any prior taxable year..

Camp 1: Pay current expenses from the health savings account

Paying for current expenses is arguably the original intent of the Health Savings Account. You make tax-free contributions to the HSA and then you use that money to pay for medical expenses as-and-when occurred. It’s how Charlie is using the account, which is why the kids are eating through the annual HSA contributions.

If you’re not maxing out your retirement accounts, then it almost certainly makes sense to pay for your current expenses from the Health Savings Account.

For example, imagine a $100 qualified medical expense and a 25% marginal tax rate. You’re deciding between using $100 from the HSA or $100 from your pocket. If you take $100 from the HSA to pay for the expense today, that leaves the $100 in your pocket to contribute to a Roth IRA or $133 to contribute to a 401(k).

If you take $100 from your pocket to pay for the expense today, that leaves you with the right to withdraw $100 from your HSA account at any time in the future (and you’ll be able to spend that $100 however you want).

In the first scenario, if you invest the $100 into a Roth IRA, you’ll not only be able to spend the $100 in retirement on anything you want, you’ll also be able to spend the investment gains from that $100 tax-free as well. The math is the same if you invest the $133 into a 401(k) after adjusting for a 25% income tax paid on withdrawal in retirement.

In the second scenario, you’re only able to withdraw the $100 from your HSA. The investment gains will continue to accrue but those gains can only be used for qualified healthcare expenses (to get tax-free treatment) or else you’ll be required to pay income taxes upon withdrawal on those investment gains.

In other words, it’s better to take advantage of the Roth IRA and get the $100 + investment gains completely tax-free than it is to get $100 from the HSA + pay taxes on the investment gains or be limited to using the money for qualified medical expenses.

There’s also another compelling reason to pay current expenses from the Health Savings Account. If you want to withdraw the money in the future, the burden is on you to show that the costs haven’t already been reimbursed in another way and that you haven’t taken a deduction on those expenses.

Many people do not want that burden.

Camp 2: Pay current expenses out-of-pocket; let HSA grow

If you’re already maxing out your retirement accounts, it makes mathematical sense to pay your current expenses out-of-pocket, save receipts and let the HSA continue to grow.

For example, imagine a $100 qualified medical expense. You’re deciding between using $100 from the HSA or $100 from your pocket. If you take the $100 from the HSA to pay for the expense today, that leaves the $100 in your pocket to contribute to a taxable investment account. You’ll be able to use that $100 in the taxable account whenever you want by selling the investment, but you’ll pay taxes along the way on capital gain distributions and dividends, as well as capital gains taxes when you sell.

If you take the $100 from your pocket to pay for the expense today, save your receipts, and let the HSA continue to grow, you’ll be able to withdraw the $100 from the HSA at any time. However, the investment gains from the $100 will continue to accrue inside the HSA. You will be able to use those investment gains towards qualified medical expenses (tax-free), or you’ll be able to withdraw them after 59½ at ordinary income tax rates.

In my review of other writers on this topic, I haven’t seen many point out that by making the decision to leave the funds in an HSA you’re trading capital gain tax treatment (had the $100 been invested in a taxable account) vs ordinary income tax treatment (if you end up withdrawing the money from the HSA after 59½ for anything other than qualified medical expenses). That’s not a great trade to make.

I think this point isn’t mentioned because most assume that medical expenses will be significantly high in retirement that it shouldn’t be a problem to find qualified medical expenses in the future. After all, you can use an HSA to pay for Medicare premiums. After you hit 65 and qualify for Medicare, that’s a significant recurring qualified medical expense for your HSA.

For that reason, I think it’s reasonable to assume that you’ll be better off by keeping the money in the HSA and taking advantage of any investment gains within the shelter of the Health Savings Account.

Overfunding your health savings account

It’s possible that you can contribute too much money to your Health Savings Account, but I don’t think it’s something many lawyers should be worried about. If you get to the end of your life and have excess HSA funds, that’s a wonderful problem to have. The account can still be treated as a Traditional IRA, so you can make withdrawals and spend as needed.

If you die with a balance, your HSA transfers to your spouse. If you don’t have a spouse (or elect someone else to be the beneficiary of the HSA), they’ll inherit a fully taxable lump sum amount subject to ordinary income taxes. While I’m sure they’ll still be happy to receive it, if it’s a kid in her peak earnings years, she may have a high marginal tax rate applied against it.

There’s also the problem that your estate may have the unfortunate task of needing to sort through your old receipts to figure out how much of the HSA can be withdrawn tax-free, but there’s no reason to think that the estate wouldn’t be able to do that.

One way to simplify this scenario would be to create a donor-advised fund (if you intend to leave a certain portion of your estate to charity) and make the DAF the beneficiary of your HSA.

How do I handle my health savings account?

Given the relatively low contribution limits, I plan to continue to max out my Health Savings Account indefinitely. I’d be pleased if I end up in a situation where I have ample funds left.

I am paying for medical expenses out-of-pocket and keeping receipts as I go. I have a spreadsheet where I record each medical expense and then a digital folder where I save all of my receipts.

I understand why some people are reluctant to deal with this paperwork but keep in mind that you don’t have an affirmative defense to get access to the HSA funds, you need a record in case the IRS audits you in the future. Like many things related to the IRS, reimbursing yourself for HSA expenses relies on the honor system.

Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He knows that the Bogleheads forum is a great resource for tax questions and is always looking for honest advisors that provide good advice for a fair price.

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    Twenty-one thoughts on HSA: Pay for Expenses Now or Later?

    1. I hadn’t thought of setting the beneficiary as a daf. Good advice there. I tend to book when it occurs but then again I don’t trust the government not to change the rules.

    2. Good discussion of the pros and cons of the different approaches to HSA spending.

      For a couple years, I decided to pay out-of-pocket and save receipts, planning to take a big payout someday in the distant future. However, my process of scanning, saving, spreadsheeting, etc… proved to be rather cumbersome. I’m not in the pay-as-you-go camp after “cashing out” the receipts I had saved up so far.

      As such, my HSA hasn’t grown much. Most years, we spend close to the $6,950 out-of-pocket. All it takes is one surgery and a handful of clinic visits with our HDHP to hit that mark.


      1. Thanks for weighing in Doc. Your comment made me think about it from another perspective – let’s say you decide not to save receipts (too time-consuming) but yet still pay for current medical expenses out-of-pocket, while letting your HSA grow.

        Here’s how those numbers would look in a hypothetical, fudging a bit on the numbers by not taking into account tax drag.

        Scenario 1 at age 65 (Never bothered to get reimbursed from HSA; never saved those receipts either):
        $0 – Taxable Account
        $50K – HSA Account

        Scenario 2 at age 65 (Took reimbursements along the way and put those reimbursements in a taxable account).
        $50K – Taxable Account
        $0 – HSA Account

        And then let’s assume that after age 65, you have $50K in medical expenses. In Scenario 1 you draw from the HSA Account and in Scenario 2 you draw from the HSA. It’s really the same difference, with the key being that so long as your HSA isn’t overfunded, you’re fine either way. In other words, it’d be a bad outcome if you only had $10K in medical expenses after age 65 since you would now have to withdraw the other $40K from the HSA subject to ordinary income tax rates.

        The benefit is that in a real-world scenario your HSA account will grow to be more than $50K and your Taxable Account will be less than $50K (thanks to the tax drag).

        The question is whether it’s worth the extra gain vs the risk of potentially having an overfunded HSA. I can’t say which is better but just food for thought.

        For us, we have very few medical expenses so it’s made it easy to be in the “save receipts” camp (I don’t find it cumbersome saving 1-2 receipts a year) but that could all change going forward with kids as the original poster Charlie suggested.

        1. Great thought exercise — the key is to minimize tax drag so the difference will be small. There is more future risk, too. What if we end up with a single payer system for healthcare? Will we ever be able to spend that HSA money tax-free on medical expenses?

          If it turns out that I made the wrong choice in hindsight, I won’t regret it — it’s a very small piece in our financial puzzle, and I can live with a slightly suboptimal handling of it if it makes my life a bit easier.


          1. That is the dream scenario. I could live with not being able to spend the HSA money tax-free on medical expenses because we ended up with a single payer system for healthcare.

    3. Really like the pros and cons of whether to spend HSA money on current expenses or cash flow it now and reap a benefit later of triple tax free advantage.

      I am in the pay cash now and fully fund the HSA camp personally. I think there will be a lot of medical expenses in future that will more than eat up my HSA account even without requiring receipts from current health care service costs.

      As you mentioned, Medicare is an allowable triple tax free expense. Studies have shown a couple in their 60s will likely have 250k+ of medical expenses in retirement. Also long term care will likely deplete whatever funds remain. And if there is any money left over it’s not the end of the world as it can be passed to heirs (albeit like you mentioned it will be taxable at that point).

      I’m 47 and have about $67k whittled away in my HSA account currently. I am in the early retire camp so figure I will work another 5-6 years and try to bulk that amount up even more. Hopefully that can balloon to the point where I won’t be concerned with medical expenses at all in retirement.

    4. For a few years, I’ve been contributing to my HSA and have never withdrawn a penny. I discussed this socially with a tax attorney in my office about a year ago, and at first she couldn’t fathom how it would be beneficial to leave the money there. It’s tax-free for that purpose, why not use it rather than bringing taxable money home to pay a bill?

      I clarified, as succinctly as I could, like this: I think it’s going to be the best call in almost all situations where a household can max out all pre-tax investments and still cover medical expenses with after-tax income. In that narrow circumstance, letting the money sit provides all the income tax benefit and much more capital gains benefit than any other use of the account, and it comes at zero cost since you’re bringing home that other money and paying tax, anyway.

      Yesterday, there was a presentation about our changing insurance. The presenters mentioned using an HSA as a long-term, tax-minimizing investment account rather than withdrawing. I wasn’t at the presentation, but apparently they showed this with various charts and graphs in some fancy Powerpoint. She left the meeting and told me I had been vindicated.

    5. What is the scenario where one can skip saving receipts for qualified expenses? Are you guys suggesting that if one uses the bank card/credit card provided by the institute that provides the HSA account then no documentation is needed? If so, who checks and makes sure the charge is a qualified charge indeed? I have started using HSA plan this year. I find it little bit cumbersome yet benefits overweigh the burden.

    6. Hello, I’m a 42 year old diabetic with relatively high medical expenses & a $3000 out-of-pocket max. I will likely have 20-30 charges adding up to $3000 in 2019.

      I’m leaning towards Camp 2 paying out-of-pocket and saving my receipts until retirement.

      I’m thinking of scanning my receipts as I go (I have a CamScanner app on my phone) and saving them to a folder on my Google Drive with the date and whole dollar amount in the title. What’s the benefit of also saving them in a spreadsheet? And what info are you spreadsheeters logging?

      1. I have a 2% cash back credit card, so as a small bonus I would wind up $60 cash back on the $3000 medical spend. I will look at compensation for time spent scanning and saving.

        Does anyone have a more efficient system than scanning & saving to Google Drive?

    7. Ha! A more efficient system!? I used all my funds the first couple of years of having an HSA as the tax advantage it was intended for. Since then I’ve been saving it and paying out of pocket. I was thinking maybe it better to go back to the old way of using it every year because maybe in retirement I’ll be in a different tax bracket and can write off my medical expenses or as someone else brought up, the health care system may change by then. It’s all really a guessing game and a lot of paperwork that the government likes to play with us. They try to make us think they’re so generous with what they allow us to do with our hard earned money! All these things they come up with to save us tax dollars are so burdensome; one reason why we’re on this website trying to “figure out the best way”. If your rich enough you don’t need them and if your poor enough you can’t afford them.

    8. great discussion thread and i am embarrassed to ask this question because it may have been in the reading. I thought you could only get reimbursed for your medical spending in the year the expense occurred. since everyone is talking about scanning, does that mean you can pay cash now in year 1 and reimburse yourself in year 10?

      1. That is correct. Any eligible medical expense incurred after establishment of the HSA for which you paid out of pocket. I have had an HSA for 10 years, never used it for paying medical bills or reimbursing myself for such to this point. I have approximately $35,000 in “banked” receipts over those 10 years for future use and a total balance of $100,000+ in the account (due to investment returns). I can take some or all of that $35k at anytime. The triple tax advantage makes it the single greatest vehicle out there. I will continue to Max it out and roll it forward until I actually need the money.

    9. Fantastic article which many more people should read! I however was convinced of scenario 2 long ago that paying out of pocket while letting the HSA grow was the only choice. I learned this from my kids 529’s. I’ve been saving for their college since the day they were born putting away a small amount every month. Now that my oldest has just started college, every $1 that I contributed has turned into $4 in his college savings account. In fact, the account is still growing faster than his withdrawals for qualified expenses! Same with the HSA. My company didn’t start this until 2015. I am now retired and still contributing, but have never made a withdrawal . The account his now worth over $75k and I still have 6 years to go until I am 65. Let it grow, let it grow!

      1. That’s great to hear. Thanks for leaving this data point for other readers to find. As you already know, it’ll be great from a tax perspective if you use that money for health expenses but if you end up in perfect health it’ll make a nice traditional IRA too! Meanwhile, the power of compound interest will be pulling heavily in your favor.

    10. You have an error in the 5th paragraph above: “Even if you end up with perfect health or never have any medical expenses, after you reach age 59½ you can withdraw money from a Health Savings Account in the same way as a Traditional IRA and use the funds for whatever purpose you want, such as covering living expenses or a trip to Paris.”

      The age at which this happens in 65, not 59½.

    11. Two additional advantages of an HSA that are often times overlooked are:

      1.) There are no RMDs for an HSA.
      2.) HSA contributions do not pay FICA taxes (~7.7% savings).

      These are both big advantages over a 401k.

      So if you end up over contributing to an HSA, at worst, it is a Traditional IRA with no RMDs, that you can withdraw penalty free from after 65.

    12. Hi there, at least one major HSA brokerage does not allow submission of receipts after the current year (or in same cases as long as two years, but never more than this.)

      Though the IRS states that there is no time limit as long as the account was opened prior to the receipts, it seems that at the brokerage level, it is possible there are rules in place preventing you from saving up receipts for say, 25 years.

      There must be a subset of brokerages where this limit is not in place. One would have to create an account at a brokerage that did not have this limit, and then fund it via transfers, etc.

      Does anyone have experience with this?

    13. Bumping the above comment – anyone else have experience with their HSA custodian limiting the timeframe of banked receipts?

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