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Our situation: my wife and I (both 30) are expecting to incur substantial health expenses this year for some upcoming dental surgeries she needs, somewhere in the range of $12k-$14k. We're currently on a low-deductible plan, but I have ~$6,500 in a HSA from a previous job (where we had a HDHP at the time). Given the fixed principal and small size of the account, I don't really see the account as a major part of our retirement strategy. We have sufficient savings in the bank to pay for the surgeries without needing to draw down our emergency fund. Those savings were otherwise earmarked for upgrades to our home we were wanting to start next year. In short, we could fund $6500 worth of the surgeries out of either my HSA or our home upgrade savings.

My question is: should we take a distribution from the HSA to (partially) reimburse ourselves?

I see a few options:

  1. The very conservative approach would be to treat the HSA as a retirement account and refuse to touch it. This would delay when we could make those home upgrades by 4-6 months (assuming no changes to our current savings rates), but the account could continue to grow tax-free until retirement.
  2. If we took the distribution now, we would put the money into CDs and eliminate the market risk, guaranteeing the money would be available when we want to fund the upgrades.
  3. Since there's no time limit on distributions, we could hold the option to take the distribution at some point in the future (such as to make those home upgrades earlier). This would be subject to market risk. If the value of the account increases, we could even reimburse a larger amount. If the value of the account declined materially (indicating a broader, sustained recession as the account is holding total market index funds) we might wish to delay the upgrades anyway.

After writing all that out, I'm leaning toward option 3 (delay the decision), but want to know if there's anything else I should be thinking about?

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Do not do #2!

Why? As soon as you take it out of the HSA, you have to pay tax on any new earnings from that moment on. If you leave it in the HSA you don't have to pay tax on the earnings, and it's likely you won't have to pay taxes on those earnings when you withdraw it later either.1 I'm basing this on the fact that you're going to have at least $12K-$6500=$5500 in expenses beyond your current HSA balance, which means at least the first $5500 in growth will be tax free. Surely you'll have other eligible expenses in the future, and if so, growth beyond that $5500 will likely be tax-free as well.

This leads to 2 conclusions:

  • Don't take any money out of the HSA until you actually need to use it.
  • Your risk profile for the funds doesn't necessarily need to differ much whether the money is in an HSA or not. For example, if you would put the money into CDs outside of the HSA, then consider doing the same while inside the HSA. It's the identical risk but the interest earned is tax free when inside. The same is true for most investments.2

If you try to abide by my first rule, you'll end up naturally selecting your option 3, and note that your option 1 is just a subset of option 3 if you don't ever need to take it out before you retire. From there you simply decide what type of risk profile you want to guide your investments.


1 Note HSA earnings are taxed in some states (currently CA and NJ), and in those states the benefit is limited to just saving on federal taxes.

2 Although generally true, there are certain scenarios where investments don't make sense in the context of tax-advantaged accounts. One example is municipal bonds, which may be tax free regardless, yet typically lower returns than regular bonds, so there isn't much benefit to buying them inside of an already tax free account. (With the exception of possibly avoiding state taxes in CA and NJ.)

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    One thing to mention is that HSA is not necessarily tax free. For those living in California or New Jersey, HSA is considered a regular brokerage account for State tax purposes and is taxable. So there still may be some advantages to munis even in HSA.
    – littleadv
    Commented Jan 3, 2023 at 22:00
  • @TTT thanks for the answer. What do you mean by "have to pay tax on the earnings"? I was under the impression that you could use any money in an HSA to pay for medical expenses without paying taxes. Also, unfortunately my HSA provider doesn't offer CDs, mostly index funds. Commented Jan 3, 2023 at 22:06
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    @user1993951 That's correct. I meant if you're taking the money out and then putting it into CDs, you pay tax on the new growth, whereas if you leave it in the HSA and buy the same CD you don't pay tax on that growth. I added the word "new" to the answer to clarify this. As for your HSA provider not offering CD's, neither does mine, and with the current rates as high as they are I'm considering switching my HSA provider for that exact reason...
    – TTT
    Commented Jan 3, 2023 at 22:16
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    Thanks for clarifying, that makes sense. I hadn't thought about switching, but since I'm no longer tied to that employer, I suppose I could. It seems like the main advice here is to not forgo the tax-free growth, and only to take the distribution if I absolutely have to. Is that right? Commented Jan 3, 2023 at 23:12
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    @user1993951 yes, exactly.
    – TTT
    Commented Jan 3, 2023 at 23:18

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