Health Savings Accounts: Defer Reimbursement But Keep Receipts Forever

I always tell myself to do more research on Health Savings Accounts (HSAs), but I lack motivation because we have great health insurance benefits and not even the option of an HSA-eligible high-deductible plan. I know, what a tough problem to have ;).

Still, the benefits of HSAs include tax-deductible contributions, tax-free earnings growth, and tax-free withdrawals when used for qualified medical expenses. Because of this, HSAs are often nicknamed “Healthcare IRAs” and have the potential to be very useful for retirement planning.

A popular tip is to contribute the maximum allowable amount to your HSA every year ($3,300 individual, $6,550 family for 2014) and then invest that tax-deferred money so that you can have a big pile of money eligible for healthcare expenses when you are old and creaky. Some people recommend not taking any withdrawals even if you have current medical expenses and just pay for it out-of-pocket. This way, your contributions will be able to enjoy potentially decades of tax-free growth. There is no maximum allowable balance. There is no mandatory disbursement age.

In addition to all that, the Mad FIentist has a great post on How to Hack Your HSA where I learned that:

  • There is no time limit between when you incur a qualified healthcare expense, and when you can make a tax-free withdrawal of the same amount.*
  • By saving up all your medical receipts but not claiming them, you can effectively defer that qualified withdrawal indefinitely. For example if you pay your $2,000 bill now, you’ll still be able to take out $2,000 tax-free at any time you wish in the future. Meanwhile, that initial $2,000 can be left in there to grow in a variety of investment options, like stock index fund or ETF.

Now, you can still only take out $2,000 tax-free and not whatever that $2,000 grew to. However, as you get older you will likely have more medical expenses including copays or coinsurance payments. HSA money can also be taken out tax-free to pay for COBRA premiums and Medicare deductibles and Part B/C/D premiums. Finally, once you reach age 65, withdrawals for non-qualified reasons will be taxable as income without penalty, acting very similar to a Traditional IRA. If you did that before 65, you’d be subject to a 20% penalty.

This is an intriguing wrinkle, but I’d be wary of keeping my receipt for 20 or 30 years and then trying to redeem them. The IRS states that you “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”. What if the IRS starts asking questions? The doctor’s office that did the procedure may be long gone. How do you prove that you didn’t just Photoshop the receipt?

* Here’s the proof. Jeremy of GoCurryCracker provided this helpful 2004 IRS Bulletin that clarified the issue.

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. See Notice 2004-2, Q&A 31 and also Notice 2004-25, for transition relief in calendar year 2004 for reimbursement of medical expenses incurred before opening an HSA.

Comments

  1. Matt Behrens says:

    One thing to watch out for is minimum balances and fees with HSA account. It seems like for how “new” HSA accounts are, there isn’t much competition for accounts yet and there are a large amount of bullshit fees, compared to checking/saving accounts.

    • One of the advantages of the HSA seems to be that you get a deduction on FICA taxes, which regular IRA and 401 (k) contributions do not do.

      The disadvantage is that you do not have many options on what to invest the money, besides index funds.

  2. Hey Jonathan, thank you very much for linking to my article! I’m glad to hear you got something out of it.

    I keep digital copies of my receipts so that I don’t stress out about misplacing the physical receipts. If the IRS ever did audit me, I imagine they would rather see a nice clean digital copy than a disintegrating, 20-year-old paper copy anyway :)

    Great article and thanks again for the mention!

  3. I put a decent amount of money into HSA, but I make sure I maximize everything else before I do that. I basically treat it as it is – a place to stash money for medical cost.

    The problem with my HSA is the selection of investment and fees. There is a monthly fee if I choose to invest the money, and the funds available within the HSA are both on the higher end of cost structure. There are also transaction fees if I choose to actively manage the account…

  4. Luckily, we afford to use our HSA accounts as a “Healthcare IRA”. Yes, the documentation/receipts requirements are a minor pain. In the long run though, it’s worth it. For us, the fees are generally very low — we use HSA Bank and Ameritrade for our accounts (they’re linked). I tend to run the asset allocations very conservatively in case I do need cash … maybe 1/3 equities, the balance bond funds and cash. One nice thing about HSA Bank is that they pay a very high interest rate for their HSA savings account.

    One downside, something that we learned after we opened our HSA accounts. The State of California does not treat HSA accounts like an IRA, so any income is taxable. So, we will tend to keep these account investments really simple. This is one area where state and federal law should be synchronized but they’re not.

  5. I’m somewhat unnerved to keep really high balance in my HSA for future even though I do contribute to the maximum allowable extend. The problem as I see it, being pessimistic about it, that the gov can (and often does nowadays) change the rules easily. The changes even can be applied retrospectively. The qualified expenses, the allowed spending max, the time limit from qualified event, even the tax-free status – all is based on government promise today.
    Now, I’m not preaching spend-all approach. Just adjusting to current reality.
    I’d be crushed to loose it all.

    • I have HSA Bank as the administrator also. HSA bank uses Ameritrade for the investment side. As of 12/18/2013, HSA bank charges $2.50 monthly if HSA bank balance is below $4850 (2014 $4925) and for the privilege of investing at Ameritrade, monthly $3.00. HSA bank has been increasing the fees every year, irritating.

      For the past 5 years, I can not find a HSA administrator that uses outside broker, such as Ameritrade, and doesn’t nickle and dime you monthly. If they don’t hit you with the monthly fees, they will charge an “annual fee, ~$35″, or “inactivity fees ~$25-$35″.

      Even though HSA Bank charges monthly fee, HSA Bank gives a decent investment option from the Ameritrade side. Also, Ameritrade has an expanded list of “NO ETF trade fees” which includes Vanguard, Fidelity, etc. Ameritrade doesn’t advertise the the “no etf trade fees”, search for it or call Ameritrade to put your account or opt-in the “no etf fees” . Hey, every dollar helps.

  6. Could someone please clarify this part of the IRS bulletin for me: “However, to be excludable from the account beneficiary’s gross income, he or she must keep records sufficient to later show that … the medical expenses have not been taken as an itemized deduction in any prior taxable year.” So, if I start saving up money in my HSA account without taking distributions and end up itemizing my medical expenses one year, I won’t be able to reimburse myself for that year in the future?

    • Yes, Denis… that is exactly what it means. You cannot take a deduction for an expense and also reimburse it from your HSA–to do so would be akin to taking a double deduction. Reimbursements from an HSA are really just a simplified way of taking a deduction for the expense–a method that allows you to do so without having to meet the income % criteria to take the deductions on your tax return.

  7. Best HSA Administrator / accounts that I have found are Alliant Credit Union. They have no fees for HSA accounts (monthly or per transaction) and good interest rates (0.65% APY currently).
    http://www.alliantcreditunion.org/depositsinvestments/healthsavings/

    I have used their HSA accounts for past 4 or 5 years without any issues.

    They are a credit union so you need to make a $10 “donation” to a local charity to gain eligibility to join.

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