Most people suggest the first one, paying out of pocket. This is the tax consequence:
- Pay out of pocket: Money grows tax free. Pay income tax on non-medical withdrawals at the end.
For the vast majority of Bogleheads, there should be very little chance of the last sentence. Medical expenses for someone retiring in 2017 can run well into six figures in their lifetime.
First, most people underestimate what their HSA qualified medical expenses will be in retirement. First, there are Medicare Part B and Part D premiums and many BHs will be subject to IRMAA. Also, any insurance premiums except for Medicare Supplement Plans are qualified. You can switch a significant amount of that Medigap cost from non-qualified premiums to qualified medical expenses by enrolling in the high-deductible plan F (G enroll >= 2020). All out-of-pocket medical, dental, vision, and hearing expenses are qualified medical expenses. As are Long Term Care
(LTC) insurance and/or out-of-pocket LTC costs.
The optimizations in the accumulation and withdrawal phases are:
- Not maximizing tax-advantaged accounts: Reimburse all qualified medical expenses from HSA. Use reimbursements towards maximizing tax-advantaged accounts. Gross up for pre-tax contributions.
- Maximizing tax-advantaged accounts: Pay qualified medical receipts out-of-pocket save receipts and reimbursment for retirement.
- Tax-free: If you wish to take tax-free distributions at any time, reimburse the HSA encumbered tax-free assets first.
- Pre-tax: Always take distributions from other pre-tax assets first. Pre-tax distributions from an HSA should be a last resort.
Note: Caveat to HSA owners who have only non-spouse beneficiaries. Do not die suddenly. Probably should reimburse from HSA sooner rather than later in retirement. Spouses should tell spouse beneficiaries to do the same after they pass, or maybe the HSA account owner should clean up their own mess before they go.