HSA Money: Cover Expenses Now or Let It Grow?

It’s that time of the year when I tally up the eligible health care expenses incurred in the previous year and request reimbursement from my Health Savings Account (HSA).

I don’t use the HSA debit card at the time of service because you never know how much the provider is supposed to write off due to in-network discount and how much insurance will end up covering. I just wait until the dust settles and pay my part of the bill out of pocket — with a rewards card — after the claim runs through insurance.

I put the EOBs in a folder and I record what I paid in a spreadsheet. After the year closes, I request one lump sum from my HSA to reimburse what I paid out of pocket during the year.

When it comes to how to use an HSA, there are primarily two camps. One camp, to which I belong, uses the HSA money to cover current out-of-pocket expenses. One can argue it’s the way an HSA is “supposed to” be used. Another camp would save the receipts but not request reimbursement. They let the money grow in the HSA. Some call the HSA a “stealth IRA” when they use it this way.

Not requesting reimbursement is certainly allowed. The point of saving the receipts is that those expenses will be allowed to be reimbursed at a later time. That later time can be 30 or 40 years in the future. Between now and then, the money grows in the HSA tax free. The difference would be similar to that between a taxable account and a Roth IRA.

Waiting 30 or 40 years before requesting reimbursement is allowed. There was this Q&A in IRS Notice 2004-50 issued in 2004 (emphasis added by me):

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.

It explicitly said “in any prior year” and “there is no time limit.”

So why do I not take advantage of it and let the money grow tax free for 30 or 40 years then? Note the Q&A doesn’t end with just “there is no time limit.” There is a however after that. The however part puts the burden on you to show that the expenses haven’t been already reimbursed in another way and that you haven’t taken a deduction on those expenses.

I don’t want that burden.

There is a famous saying “you can’t prove a negative.” When you dump 40 years worth of medical expenses on the table, how exactly do you show that they haven’t been reimbursed in a different way? When the burden is on you, you will necessarily have to go through 40 years worth of other records to show that you didn’t reimburse those expenses. If I say “maybe you reimbursed in year 13?” you will have to show your other records in year 13 — “nothing here.” “What about year 19?” You will show year 19. You end up having to show your other records for each and every year in all 40 years.

By choosing to take a distribution every year to cover the eligible expenses incurred in the previous year, I close the chapter and move on. I lose a few hundred dollars worth of future compounding but I also not worry about keeping the receipts and other records forever. Peace of mind makes it worth it.

[Image credit: Flickr user Canadian Pacific]

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  1. Ralph says

    I print out a report of the insurance company records for the year showing all charges, co-pays, deductibles, and reimbursements. I upload this summary and totals to the HSA account documents section of my account. This preserves a permanent record with the HSA showing the amount I can withdraw taxfree for a given year, that I can access in future years for withdrawals. The same can be done for dental.

    • Erik Neu says

      I think you are on the right track. In this thread and similar ones, everybody seems to obsess about: 1) Saving every little receipt; 2) “Proving a negative”. As you indicate, just print off the Health Statement(s), from your Insurer, at the end of the year, to show how much you incurred Out-of-Pocket. I think by definition, those expenses must be valid. Much simpler than saving each and every receipt. Granted, for things that are not covered by insurance–as opposed to being subject to a high deductible–such as Lasik, it wouldn’t work. But it would eliminate the need to keep receipts for the nickel-and-dime stuff, notably prescriptions.

      As for proving a negative, I think people are over-thinking it. If your insurer did not pay the expense, who else would have paid it? The only answer I can think of is your spouse’s policy, in the (increasingly uncommon) case you have “coordination of benefits”. But again, the statements from your insurer would indicate a COB situation. So that negative is not so hard to prove.

      The important advantage to doing this, that I think most people are overlooking…with a 401k or traditional IRA, you get a current tax deduction, but you pay taxes on the distributions. With an HSA, the contributions are tax deductible now, and if the distributions are for medical expenses, they are tax-free–including the earnings. That last part is the key. If you take distributions as you incur them, you forego the tax-free compounding. Yes, you could just as easily contribute the same amount of money to a 401k or IRA (assuming you are not maxing out). But when you eventually take distributions from those accounts, you will be paying tax on the earnings. Not the case with the deferred HSA distributions, so long as they are for qualified medical expenses.

    • Harry Sit says

      The amount not paid by your health insurance could be covered by worker’s comp, an injury settlement, class action and so on. It could’ve been appealed and paid the following year.

  2. msf says

    “The however part puts the burden on you to show that the expenses haven’t been already reimbursed in another way and that you haven’t taken a deduction on those expenses.

    “I don’t want that burden.”

    You’ve got that burden even if you take the distribution for the expenses in the current year. You need to keep the records for (at least) three years after you file form 8889 for those distributions, even if you take the distributions in the current year.

    See Pub 969 (Recordkeeping requirements):

    • msf says

      Do you have to keep financial records at all? Then you’ve already got a “box” (these days, a harddrive folder or two) for those records.

      The hard part is having a filing system – which you’ve got to do anyway, with or without these medical expense records. Throwing them in the “box” is easy.

      I doubt these would be the only records you’d be keeping for more than three years anyway. Have a mutual fund investment? You’re going to have to keep all the records on all the transactions for that fund until you close out your position. That’s because you have to be able to prove which shares you sold over time and how you calculated their cost (average cost or actual cost). This in turn is required because it affects the cost of your remaining holdings.

      You’ll also need to hold onto all the investment records from all your other accounts, to be able to prove that you didn’t repurchase any shares that you sold at a loss, generating a wash sale across accounts. (Even with the new reporting requirements for brokerages, they are not allowed to report this type of wash sale, but you are still responsible for reporting it.) Talk about having to prove a negative!

      And the list goes on. Own a home? You’ll want to keep track of your closing costs and all the home improvement costs over the several years you owned your home.

      It’s a big box of records you’ve already got to keep anyway. Throwing some more stuff in the back of it is no big deal.

  3. Erik says

    I’ve been saving HSA money and paying out of pocket for five years. I have a tracker that includes scans of every bill and payment I’ve made that I am counting toward my total I can reimburse myself in the future. I feel this is working very well for me and I’d be able to show the validity of a later reimbursement.

    However, you do have me thinking about how I’d show “expenses haven’t been already reimbursed in another way and that you haven’t taken a deduction on those.” Like MSF mentioned, form 8889 would show my distributions/reimbursements or lack thereof. But it does seem like it could get messy trying to show expenses weren’t reimbursed in another way (e.g., maybe via the special circumstances an FSA is allowed to be used with an HSA).

    I’ll definitely spend some time weighing the pros of carrying this burden vs. the peace of mind with reimbursing my expenses as they happen or at least within the year.

  4. Darren says

    What about the fact that HSA funds can be withdrawn after age 59 1/2 for non-medical reasons without penalty. In that situation, the HSA basically acts as a pre-tax IRA without income limits.

    • Josh says

      Its actually higher for an HSA – age 65 before you can take non-medical distributions without penalty. Important point for retirement planning.

    • Jeff says

      But then you are paying income taxes on what you take out… it is without penalty, but if you use them for qualified medical expenses, you don’t even pay income tax on it. So, it’s still worthwhile to track all medical expenses so you can avoid taxes altogether.

  5. Josh says

    I don’t think its nearly as hard as you imply to demonstrate you weren’t otherwise reimbursed for these healthcare expenses.
    First, having an HSA requires a HDHP, which by design means you will be paying more for care without reimbursement of any kind from your insurance provider.
    Second, the HSA custodian produces annual reports of reimbursements from the account, which should be used on your tax return if you take them, and so not filing that document means you didn’t take a reimbursement from the HSA.
    Third, there are probably very few people out there who have high enough healthcare expenses to qualify for the federal income tax deduction because it has a rather high AGI percentage threshold that must be met (10%) – it should be easy to just present past tax returns to demonstrate that there was no itemized deduction taken for healthcare expenses.
    I had a high amount of healthcare expenses last year and thought I might qualify…nope!, my expenses didn’t exceed the AGI threshold, and even if I spent a little more and did exceed the threshold I wouldn’t have exceeded the standard deduction.
    For higher-income earners it should be a simple decision not to use the HSA funds – its too valuable an investment account to be used otherwise. Especially if you don’t otherwise qualify for other tax-advantage investment spaces. All that should be needed to prove that is past tax returns.

    • Erik says

      The other example I could think of might be a limited-purpose FSA that could have been used to cover qualifying dental and vision expenses. Do you think we could be asked to prove we didn’t use a limited-purpose FSA to cover an expense we claimed as HSA-reimbursable? Maybe the limited-purpose FSA would show up in the tax return as well.

    • Josh says

      Yes, I would think FSA reimbursement would count and so those expenses should never be claimed for later HSA distributions. I never signed up for a FSA because that is (to me) an example of something that’s more trouble than its worth (e.g. maximum deferment around $2k, loss of unused funds, etc.).
      The best use for an HSA is to save and invest the funds, then use them primarily for healthcare expenses in early retirement, then for general retirement expenses after age 65. That way you really shouldn’t need a giant box of past healthcare receipts to avoid a penalty. Read this for the best breakdown of why: https://www.kitces.com/blog/retirement-health-savings-account-and-medicare-using-an-hsa-to-supplement-retiree-medical-expenses/

    • msf says

      “First, having an HSA requires a HDHP”

      See my post in response to #13. _Contributing_ to an HSA requires an HDHP. Having one doesn’t.

      Which actually should be obvious from the fact that HSAs can be used to pay Medicare premiums, which means you’d have Medicare instead of an HDHP.

  6. Leigh says

    I’m on board with this. I usually don’t spend anywhere near the amount I can put into the HSA each year and this is much less of a paperwork hassle, while still leaving plenty to grow each year. My plan makes it very easy to reimburse myself for the money I spent against my health insurance plan and so I do that once I get the bill in the mail and pay the provider. I don’t reimburse myself for prescriptions because they’re generally small and I would have to upload more paperwork for that than I need to to reimburse myself for medical bills.

  7. Harry @ RSG says

    Hmm I’m actually surprised that you don’t do this.

    I pay about $1k out of pocket every year so add in 30 years of tax free compounding at an 8% return and I’m sure I’ll come out thousands if not tens of thousands of dollars ahead.

    So I’d have no problem sifting through the pdfs of my tax returns in your worst case scenario.

  8. furwut says

    My approach the last 2 years and this has been to invest the contribution and let it grow for the future. However, with a high deductible policy, the first X thousand of dollars of medical care are out of pocket making me very reluctant to seek any care at all!

    Penny wise and pound foolish?

    • msf says

      Mostly, but not completely. You may be some conditions (e.g. toe nail fungus) that are fine even if never treated. For those, it can make sense to wait until some year when you actually hit that deductible (e.g. due to hospitalization) or you have a low deductible plan.

      For other conditions, you risk serious damage to your health if you don’t seek treatment. Maybe they’ll work themselves out on your own, or maybe they are indicators of something more serious that could run up your bills (not to mention affect your health) for many years.

  9. Gary says

    I am new to the use of an HSA account. Although self employed for 35 years and always thought I was “writing off” all health care costs, why would I need an HSA? I didn’t understand that you didn’t HAVE to use it. I am now sheltering income with max contributions. I intend to continue to pay HDHC plan insurance along with out of pocket expenses and use HSA for long term care or in retirement.

    I am lost as to my need for keeping record of reimbursed costs and deductibles – neither of which I have being self employed. It seems I would use HSA for expenses and have receipts for every time and date used – 15 yrs from now. Too simple?

  10. Beth says

    I’m in the camp of leaving the money in my HSA to grow tax free. If I start using my HSA after I retire, but before age 65 for current (at that time) medical expenses, why would I need any old documents to prove that I did or didn’t expense previous medical items? I would maintain the current receipts for what I am expensing to my HSA. What am I missing here?

    • Ralph says

      This issue is, if you keep track of your unreimbursed medical expenses, then in futures years you can withdraw those funds tax free. Here’s an example. If you are 30 in 2015 with an HSA and had 1,000 in unreimbursed medical expenses in 2015, you could take the 1000 out of the HSA immediately, of pay out-of-pocket. Alternatively, you could leave the 1,000 in the HSA and let it compound for 35 years. Then in 2050, if you have your 2015 expense documentation, pull out the 1,000 tax free and leave the compounded balance in the HSA to pay for future expenses.
      This is a big advantage over FSAs where you have to use it the same year as the expense. So the question is, is the recordkeeping burden worth the benefit of the tax free compounding.

    • Harry Sit says

      If you are sure your future medical expenses are large enough to use up your accumulated HSA balance then no problem. If they aren’t large enough but you didn’t save old receipts, the excess you withdraw becomes taxable whereas they could be tax free if you withdrew earlier when you had receipts or if you saved the receipts.

    • Beth says

      Thanks Harry. Since I just got access to an HSA in 2014 and I’m 56 years old, I’m quite assured of never needing to withdraw earlier medical expenses. I never thought about the lucky younger people who have all those years to build up quite a balance!

    • Steve says

      If you live until average life expectancy (78 years old – but that includes people who died young in the average, so really, longer) then you’ll surely have plenty of medical expenses. If you don’t then you got “lucky” to not have those expenses and/or died before running out of money. An inherited HSA kinda sucks, but, it’s not the worst thing in the world. Personally I would rather pay tax on the HSA inheritance (which keep in mind, was deferred from when you contributed, so at worst it’s a tax deferred account with an upside) than keep records for 40 years, then try to make sense of 40 years worth of records (by which time my ability to do complex math will have declined).

  11. Denise says

    I am retired and my insurance is through the marketplace. My question is can you have an HSA when retired and using the affordable care act? I dont have earned income however I do have investments and ss that I pay taxes on.

    • msf says

      Yes, and yes. (The first to the question you meant to ask, and the second to the question you did ask.)

      The question I think you meant to ask is whether you could contribute to an HSA even if you don’t have employment income. The only requirements for contributing to an HSA (from Pub 969) are:
      – You are covered by an HDHP (high deductible health plan)
      – You have no other health care (with a few exceptions, like dental)
      – You are not on Medicare (which seems redundant, as that would be “other health care”)
      – You’re not someone else’s dependent.

      The question you asked – whether you could have an HSA, is yes – if you had an HSA last year, then even if you don’t qualify to contribute this year, no one is going to take that HSA away from you. You get to have (keep) that HSA, and to use it for ongoing qualifying expenses (as well as for past expenses).

      I’m in that situation now – I may go back to an HDHP in the future, but this year it made more sense for me to use a different health plan.

  12. msf says

    Another thought on where reimbursements could come from, and proving a negative… Note, I don’t believe this is a problem, but it’s amazing how fouled up the whole system is.

    Right now, I’ve got a fairly incompetent insurer. My 2015 plan (not HDHP) required copayments for doctor visits. I made those copayments as required by my policy and by the terms on my insurance card. But the insurer didn’t give me credit for those payments toward my deductible. So now it is telling me to go to the doctors and get refunds (even though those copayments were required)!

    Say I do get those refunds. Then my copayments were reimbursed. So I can’t use them for withdrawals from my 2014 HSA. And I won’t.

    But I’ve still got the original bills and proofs of payment. I could show them to the IRS and not mention the refunds I get from the doctors. How’s the IRS going to know that I did get those refunds?

    More importantly, how’s the IRS going to know that the same thing didn’t happen to you? How do you show that your doctors didn’t give you your money back?

    This has got nothing to do with claiming the expenses in a later year – it’s a problem even if you withdraw money from the HSA in the year you incur the expense. In fact, had I done that in 2015, I’d now have a problem, because what was a legitimate withdrawal at the time just became invalid.

    Hopefully your insurers are a bit more competent. But this does illustrate how bizarre things can get.

    • Erik says

      This is the discussion I’d like to see in the comments. Just how might we end up having to prove a negative. I’d absolutely love to read a case where someone had to prove an negative with their HSA reimbursements. I’m guessing if you have your ducks in a nice, neat row that the IRS isn’t going to push back that hard, but it was suck if they did. Beyond the careful figures and documentation I’m keeping for every future reimbursable expense, I’m not doing much else to protect myself if the IRS wants to go beyond those.

  13. Scott R says

    I’m actually with Harry on this. I plan to tally up my medical expenses and reimburse myself. I should still have a pretty good chunk of money that will be left in the HSA after that. Other than the “hassle” aspect that Harry cites, here’s another concern:

    Who’s to say that they won’t change the rules later? HSA’s have already gotten some negative press at times as being a tax shelter for the wealthy. I could very easily see them becoming a hot button issue in some election season and a politician vowing to “close the loopholes”.

    Usually these types of changes are implemented in such a way that your existing funds might get “grandfathered” to work by the old rules, but there’s no guarantee of that.

    • msf says

      Unlike Vanguard that manages to close a fund immediately with no advance warning, any closing of loopholes by the government will be announced well in advance.

      You’ll have plenty of time to withdraw your money from your HSA (using your saved receipts) before it becomes taxable. Worst case, you only get say five years of tax free growth instead of 20 or 30 or however long you were hoping to keep the HSA. Still a lot better than zero years of tax free growth.

  14. Aks says

    If we take small chunk out of HSA every year, we would be less likely get audited by IRS.
    But if we wait for too long and take big chunk out of HSA claiming reimbursement for medical expense for multiple years, it may rise rad flag with IRS.
    Once IRS open the file, they may find reasons to looks at past years tax returns and invite more questionnaires.

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