Pay Roth conversion taxes with HSA funds?

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bandm
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Pay Roth conversion taxes with HSA funds?

Post by bandm » Mon Oct 28, 2019 3:55 pm

I am considering a series of Roth conversions. I found a 2018 Vanguard piece entitled: A "BETR" approach to Roth conversions", that compares paying Roth conversion taxes from 3 different sources: (1) from the IRA itself; (2) from a tax efficient taxable account (i.e., taxed at capital gains rates); and (3) from a tax inefficient portfolio (i.e., taxed at ordinary income rates). This analysis calculates what a "break even tax rate" would be for each of the 3 different sources of funds.
What I have not seen is any analysis of paying Roth conversion taxes with accumulated Health Savings Account (HSA) funds. The HSA has pretax money and is an account that can accumulate tax free and can provide tax free withdrawals (assuming you have historical unreimbursed medical expenses). It seems to me that paying Roth conversion taxed with accumulated HSA funds may be the most efficient source because you would effectively be paying the conversion taxes with pre-tax money.
In any event, I would appreciate any thoughts on this approach and also would appreciate being pointed to some analysis that anyone is aware of. Thanks

EHEngineer
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Re: Pay Roth conversion taxes with HSA funds?

Post by EHEngineer » Mon Oct 28, 2019 4:48 pm

bandm wrote:
Mon Oct 28, 2019 3:55 pm
It seems to me that paying Roth conversion taxed with accumulated HSA funds may be the most efficient source because you would effectively be paying the conversion taxes with pre-tax money.
You're looking in the rear-view mirror. Once contributed,HSA funds are post-tax money, assuming you'll have sufficient medical expenses now or in your lifetime.

I haven't read the paper, but it occurs to me that investment horizon, future tax rates, current unrealized capital gains, potential for step-up, potential for creditor liabilities, and probably other factors would impact this decision.

From a first order approximation, the most tax efficient would be to pay the tax using money in your checking account that has no tax deferred status and also no capital gains.
Last edited by EHEngineer on Mon Oct 28, 2019 4:49 pm, edited 1 time in total.
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lstone19
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Re: Pay Roth conversion taxes with HSA funds?

Post by lstone19 » Mon Oct 28, 2019 4:48 pm

Cash is fungible. You should already have a plan for in what order you will liquidate investments in order to come up with cash for any need. That the need is to pay taxes on a Roth conversion should not be a concern - just liquidate the next thing in your plan to meet the need.

An HSA, once money is in there, is in many respects just more Roth funds (no taxes on any distributions although only if offset by qualifying medical expenses). So in one sense, you should almost be indifferent between taking money out of an HSA or out of a Roth to the extent that you can make tax and penalty free distributions (but has been pointed out before, an inherited Roth is better than an inherited HSA so it makes sense to take money out of an HSA before a Roth).

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grabiner
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Re: Pay Roth conversion taxes with HSA funds?

Post by grabiner » Tue Oct 29, 2019 10:19 pm

lstone19 wrote:
Mon Oct 28, 2019 4:48 pm
An HSA, once money is in there, is in many respects just more Roth funds (no taxes on any distributions although only if offset by qualifying medical expenses). So in one sense, you should almost be indifferent between taking money out of an HSA or out of a Roth to the extent that you can make tax and penalty free distributions (but has been pointed out before, an inherited Roth is better than an inherited HSA so it makes sense to take money out of an HSA before a Roth).
Another advantage of a Roth over an HSA is that gains in the Roth can be spent on anything, while gains in the HSA can only be used for medical expenses. Therefore, it is better to spend money from the HSA than from the Roth if you can spend it penalty-free.
Wiki David Grabiner

Miriam2
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Re: Pay Roth conversion taxes with HSA funds?

Post by Miriam2 » Wed Oct 30, 2019 12:52 am

bandm wrote: I am considering a series of Roth conversions. I found a 2018 Vanguard piece entitled: A "BETR" approach to Roth conversions", that compares paying Roth conversion taxes from 3 different sources: (1) from the IRA itself; (2) from a tax efficient taxable account (i.e., taxed at capital gains rates); and (3) from a tax inefficient portfolio (i.e., taxed at ordinary income rates). This analysis calculates what a "break even tax rate" would be for each of the 3 different sources of funds.

What I have not seen is any analysis of paying Roth conversion taxes with accumulated Health Savings Account (HSA) funds.
Look at the Vanguard paper, pg. 4, fn 4. Although it doesn't expressly address the HSA, it states that its approach would apply for all tax-advantaged accounts, including the 401k. The HSA is a tax-advantaged account.
bandm wrote:The HSA has pretax money and is an account that can accumulate tax free and can provide tax free withdrawals (assuming you have historical unreimbursed medical expenses). It seems to me that paying Roth conversion taxed with accumulated HSA funds may be the most efficient source because you would effectively be paying the conversion taxes with pre-tax money.

In any event, I would appreciate any thoughts on this approach and also would appreciate being pointed to some analysis that anyone is aware of. Thanks
I don't see how paying the taxes owed on the conversion from an HSA could be a good idea.

It seems to me it ruins one of the good reasons to pay the taxes owed from an account that is NOT the IRA (or other tax-advantaged) account.

The reason is that by paying the taxes from a taxable account (and not the converted tax-advantaged IRA money), you are effectively increasing - adding more money into - the Roth with your conversion than you would be doing if you paid the taxes from the conversion money.

For example -

If you pay the taxes from the IRA converted money -
You convert $10,000 from your tIRA to your Roth, and you owe, for hypo sake, 25% taxes on that $10,000 - then when you take that $10,000 out of the tIRA you first pay the IRS its 25% = $2,500, then convert the remaining $7,500 into the Roth. Your Roth has $7,500 to grow & compound. The IRS is happy. You lost $2,500 in your tax-advantaged space.

If you pay the taxes from a different taxable account -
You convert $10,000 from your tIRA to your Roth, and you owe, for hypo sake, 25% taxes on that $10,000 - then when you take that $10,000 out of the tIRA you convert the entire $10,000 into the Roth, then take the 25% = $2,500 from your taxable account and pay the IRS its $2,500. Your Roth has $10,000 (not $7,500) to grow and compound. The IRS is happy. And you are happier :D because you have more money in your Roth.

If you pay the taxes from an HSA -
If you use an HSA, you are effectively using - and taking money out of - the same type of account as an IRA - a tax-advantaged account. You convert $10,000 from your tIRA to your Roth, so yes you have $10,000 in your Roth, but you pay the IRS from another tax-advantaged account, your HSA, so you have $2,500 less money in that IRA-type tax-advantaged account.

The whole purpose of the HSA is to grow and compound your money tax free for medical expenses which will likely occur later in your life. Why deplete that money for a Roth conversion? And if you're not 65 yet, there is a penalty to be paid since the funds are not used for medical expenses.

See this article on Roth conversions by Boglehead bsteiner, where he writes:
There are several benefits to converting to a Roth IRA.
The principal benefit is that, assuming the IRA owner
has other funds to pay the tax on the conversion, the IRA
owner is effectively shifting additional wealth into the
IRA. Converting has the effect of making a substantial
additional contribution to the IRA.
https://www.kkwc.com/wp-content/uploads ... ations.pdf.

Here is the link to the Vanguard white paper "A BETR approach to Roth Conversions" - note: keep a hard copy because Vanguard takes them off its website after 2 years.

https://advisors.vanguard.com/iwe/pdf/I ... IL:ET:2017

On page 4 of this paper (and in fn 4), Vanguard notes that the least efficient way to convert is "by paying conversion taxes using money that you would otherwise contribute to a tax-advantaged account such as an IRA or a 401(k)." An HSA is also a tax-advantaged account.

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bandm
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Re: Pay Roth conversion taxes with HSA funds?

Post by bandm » Wed Oct 30, 2019 5:58 am

Thanks for the replies. Miriam2, my initial thoughts are similar to yours. However, one difference in using HSA money compared to regular IRA money is that you don’t have to pay tax on the money used to pay the conversion tax. And, the difference in using HSA money compared to Roth money is that the HSA money used to pay the conversion tax is pre-tax money. Thoughts?

Miriam2
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Re: Pay Roth conversion taxes with HSA funds?

Post by Miriam2 » Thu Oct 31, 2019 9:22 pm

bandm wrote: Thanks for the replies. Miriam2, my initial thoughts are similar to yours. However, one difference in using HSA money compared to regular IRA money is that you don’t have to pay tax on the money used to pay the conversion tax. And, the difference in using HSA money compared to Roth money is that the HSA money used to pay the conversion tax is pre-tax money. Thoughts?
Yes, I see. I was figuring the issue from the perspective of "pack as much as possible for as long as possible in those tax-deferred accounts," while you're seeing the issue from a "paying the tax on the conversion" perspective.

I looked around and like you, couldn't find any articles or BH threads on this. But it seems to me that you (1) could use HSA money to pay the conversion tax, and that (2) yes it could have a lower tax consequence. But remember, I'm pretty much a newbie :mrgreen:

This is my thinking - (along the lines of my previous post)

1-You convert $10,000 from your tIRA to your Roth, and you owe, for hypo sake, 25% taxes on that $10,000, or $2,500 in taxes
2-You look through your receipts for $2,500 worth of medical bills you already paid from your regular checking account
3-You reimburse yourself $2,500 from your HSA to cover those medical bills, putting the $2,500 in your regular checking account
4-That $2,500 is no longer HSA money, since the reimbursement is over. Money is fungible and it is now regular money
5-You pay the IRS the $2,500 from your regular checking account. The IRS is happy.
6-You are happy because the full $10,000 went into your Roth.
7-You didn't lose $2,500 from your tax-advantaged HSA because you would have reimbursed yourself for that $2,500 in medical bills anyway
--If you would not have normally reimbursed yourself, then yes you "lost" $2,500 from your HSA tax-advantaged space
8-However, the $2,500 used to pay the conversion tax was tax-free money (when it went into & out of the HSA)

Also, seems to me you can do this at any age, even before age 65, because the withdrawal of HSA money is to reimburse the medical bills.
bandm wrote: . . . the difference in using HSA money compared to Roth money is that the HSA money used to pay the conversion tax is pre-tax money.
If you do not reimburse medical bills, then you can still withdraw the $2,500 from the HSA for any purpose, but you would have to pay taxes on that $2,500 at income rates (and if you are under age 65, then you would pay a penalty also). In this scenario, I don't see where you're paying the conversion taxes with pre-tax money.

This white paper from Vanguard indicates the HSA can be used "for a variety of long-term savings goals," not just medical reimbursements (so why not Roth conversion taxes??)

"HSAs: An off-label prescription for retirement saving" - https://personal.vanguard.com/pdf/ISGHSA.pdf
Making the most of this flexibility requires careful recordkeeping, but the flexibility also
makes HSAs an attractive vehicle for a variety of long-term savings goals. Suppose you
pay $2,000 out of pocket this year for your daughter’s braces. Save the receipt, and you
can use that bill ten years from now to withdraw funds—tax-free—to pay for her college
tuition. Or you can use it for your retirement expenses in 40 years. (pg 3)

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FiveK
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Re: Pay Roth conversion taxes with HSA funds?

Post by FiveK » Fri Nov 01, 2019 12:54 am

Miriam2 wrote:
Wed Oct 30, 2019 12:52 am
The reason is that by paying the taxes from a taxable account (and not the converted tax-advantaged IRA money), you are effectively increasing - adding more money into - the Roth with your conversion than you would be doing if you paid the taxes from the conversion money.
+1

That's the key concept.

Paying the tax from the IRA or an HSA is the Simplest situation (at least math-wise). Either way, one ends up with less tax-free money than if paying the tax from cash on hand.

Paying the tax with cash on hand is the first of the two More complicated situations described in that wiki article. See either of the two spreadsheets referenced there to calculate the breakeven tax rate for one's particular circumstances.

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Re: Pay Roth conversion taxes with HSA funds?

Post by lstone19 » Fri Nov 01, 2019 6:59 am

bandm wrote:
Wed Oct 30, 2019 5:58 am
Thanks for the replies. Miriam2, my initial thoughts are similar to yours. However, one difference in using HSA money compared to regular IRA money is that you don’t have to pay tax on the money used to pay the conversion tax. And, the difference in using HSA money compared to Roth money is that the HSA money used to pay the conversion tax is pre-tax money. Thoughts?
That the HSA money is pre-tax money is irrelevant. That's in the past. All that matters is its current status which is that it is money that (assuming qualifying medical expenses) can grow tax-free and be distributed without taxes. Therefore it is the money you want to allow to continue to grow and should be the last (along with Roths) money you want to use.

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bandm
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Re: Pay Roth conversion taxes with HSA funds?

Post by bandm » Fri Nov 01, 2019 4:09 pm

The way I’m looking at it is that because it is pre tax money I would effectively be paying the conversion tax with pretax money (say 75cents on the dollar using Miriam2’s example) AND leveraging the HSA money into 3 times as much Roth money (again using Miriam2’s example)

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Re: Pay Roth conversion taxes with HSA funds?

Post by FiveK » Fri Nov 01, 2019 4:21 pm

bandm wrote:
Fri Nov 01, 2019 4:09 pm
The way I’m looking at it is that because it is pre tax money I would effectively be paying the conversion tax with pretax money (say 75cents on the dollar using Miriam2’s example) AND leveraging the HSA money into 3 times as much Roth money (again using Miriam2’s example)
Assume you start with $10K in a tIRA, $0 in a Roth IRA, $2500 in a taxable account, $2500 in an HSA, and the conversion tax rate is 25%.

If you decide to take that $10K out of the tIRA and move all or part of it toward the Roth IRA, how much do you have in (Roth IRA + HSA) after paying the taxes with funds from the
- tIRA
- taxable account
- HSA?

Presumably the route that leaves you with most in the combination of Roth IRA and HSA will be best in the long run (ignoring the potential differences between Roth and HSA noted by other posters).

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Re: Pay Roth conversion taxes with HSA funds?

Post by Miriam2 » Fri Nov 01, 2019 6:46 pm

bandm wrote: The way I’m looking at it is that because it is pre tax money I would effectively be paying the conversion tax with pretax money (say 75 cents on the dollar using Miriam2’s example) AND leveraging the HSA money into 3 times as much Roth money (again using Miriam2’s example)
Seems to me the issue is again split between those who look at this from a "tax savings" perspective and those who look at this as a "build up your tax-deferred accounts" perspective.

OP is looking at this from the tax perspective and wants to pay the least amount of tax to convert. For sure any pre-tax money savings amount depends on whether you're pulling the money out of the HSA to reimburse medical expenses or whether you're simply withdrawing money from the HSA after age 65 to pay the conversion tax.

And - although I can't answer these Qs - it just seems to me that whether you actually save on conversion taxes depends on -
-- your tax rate or tax bracket when you contributed that money into your HSA to begin with
-- your tax rate or bracket when you convert to the Roth & pay the taxes
-- how long that money is in your Roth to grow tax free after conversion
-- what other plans you have for paying medical expenses when you're older (ie. will you need to tap taxed money because you have no HSA money left)

Maybe I'm wrong, but it just seems that if you're young and contribute that money to your HSA pre-tax when you're in a low tax bracket, and that money stays in your HSA for 20-30 years well-invested in an S&P 500 index fund and grows quite a bit, then when you're over 65 and do a Roth conversion while in a higher tax bracket, and the money only grows in your Roth for 10-20 years - how can you know that you really saved an important amount of money by using the HSA funds to pay the conversion taxes?

(although see the quoted Vanguard example about braces and college tuition in the white paper linked above 8-)

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FiveK
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Re: Pay Roth conversion taxes with HSA funds?

Post by FiveK » Fri Nov 01, 2019 7:00 pm

Miriam2 wrote:
Fri Nov 01, 2019 6:46 pm
OP is looking at this from the tax perspective and wants to pay the least amount of tax to convert.
Maybe it's semantics, but if one takes $10K out of a tIRA at a 25% tax rate, $2500 in tax must be paid. The question is then "from what source?" with a follow-up question "how does that payment affect the balances in the various account types?"

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Re: Pay Roth conversion taxes with HSA funds?

Post by lstone19 » Fri Nov 01, 2019 8:37 pm

FiveK wrote:
Fri Nov 01, 2019 7:00 pm
Miriam2 wrote:
Fri Nov 01, 2019 6:46 pm
OP is looking at this from the tax perspective and wants to pay the least amount of tax to convert.
Maybe it's semantics, but if one takes $10K out of a tIRA at a 25% tax rate, $2500 in tax must be paid. The question is then "from what source?" with a follow-up question "how does that payment affect the balances in the various account types?"
And at that point, $2,500 is due and that's the only relevant fact. It matters not why $2,500 is due (that it's due to an IRA conversion is now irrelevant as that is in the past). Whether the $2,500 is due due to an IRA conversion or due to some unexpected income matters not in the decision of from where to get the $2,500.

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bandm
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Re: Pay Roth conversion taxes with HSA funds?

Post by bandm » Sat Nov 02, 2019 7:30 pm

I am not sure I agree that the source of the funds to pay conversion tax is not relevant. That really gets to the heart of my question - does the source matter and, if so, how much? The Vanguard “BETR” article I mentioned in my original post (the one Miriam2’s provided a link to above) seems to say the break even tax rate for Roth conversions varies depending on the source of the funds used to pay the tax. The article concludes that the break even tax rate is lower using a taxable account to pay the tax rather than using tIRA money to pay the tax. My question is whether HSA funds are even better yet because of the unique tax characteristics of HSAs that I discussed above. For example, in order to have $100 in a taxable account to pay the tax you would need to earn $133 (assuming a 25% tax rate). But in order to have $100 in an HSA you would have only needed to earn $100. It seems to me that should make the break even tax rate even better. I was hoping someone was aware of an analysis of this particular application of HSA funds. I’m considering a conversion up to the top of the 24% bracket over a couple years and have accumulated a fair amount of HSA money. So this issue is important to me. Thanks again for the replies.

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Re: Pay Roth conversion taxes with HSA funds?

Post by TravelforFun » Sat Nov 02, 2019 7:46 pm

HSA is the most valuable saving vehicle one could have. I'm keeping mine until the end to pay for my medical expenses in retirement. Also, how is it legal to withdraw HSA to pay for anything (in this case, taxes) other than medical expenses?

TravelforFun

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FiveK
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Re: Pay Roth conversion taxes with HSA funds?

Post by FiveK » Sat Nov 02, 2019 7:46 pm

bandm wrote:
Sat Nov 02, 2019 7:30 pm
I am not sure I agree that the source of the funds to pay conversion tax is not relevant.
Which post(s) said the source is not relevant?
That really gets to the heart of my question - does the source matter and, if so, how much?
What is your take on the question in viewtopic.php?p=4819701#p4819701?

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bandm
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Re: Pay Roth conversion taxes with HSA funds?

Post by bandm » Sat Nov 02, 2019 9:26 pm

To me the break even tax rate is what is most relevant. Should I or should I not convert up to the top of the 24% bracket. The lower the break even tax rate is the clearer my crystal ball becomes about whether to do it or not. That’s why that is my focus and I’d like to see - if it exists - an extension of the Vanguard article specifically addressing the BETR with respect to this particular use of HSA money

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Re: Pay Roth conversion taxes with HSA funds?

Post by Miriam2 » Sat Nov 02, 2019 9:41 pm

bandm wrote: To me the break even tax rate is what is most relevant. Should I or should I not convert up to the top of the 24% bracket. The lower the break even tax rate is the clearer my crystal ball becomes about whether to do it or not. That’s why that is my focus and I’d like to see - if it exists - an extension of the Vanguard article specifically addressing the BETR with respect to this particular use of HSA money
I don't know how to answer your Q, but here is another BH thread on Vanguard's BETR white paper that may offer ideas. That thread went off on tangents, but sometimes tangents are useful :wink:

Vanguard Paper on Roth Conversion Analysis - www.bogleheads.org/forum/viewtopic.php?f=10&t=254680

https://advisors.vanguard.com/iwe/pdf/I ... IL:ET:2017

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FiveK
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Re: Pay Roth conversion taxes with HSA funds?

Post by FiveK » Sat Nov 02, 2019 10:46 pm

bandm wrote:
Sat Nov 02, 2019 9:26 pm
To me the break even tax rate is what is most relevant. Should I or should I not convert up to the top of the 24% bracket. The lower the break even tax rate is the clearer my crystal ball becomes about whether to do it or not. That’s why that is my focus and I’d like to see - if it exists - an extension of the Vanguard article specifically addressing the BETR with respect to this particular use of HSA money
Paying the tax from the IRA or an HSA (assuming the HSA funds may be withdrawn tax-free) is the Simplest situation (at least math-wise). The BETR is the same as the conversion marginal rate.

Paying the tax with cash on hand is the first of the two More complicated situations described in that wiki article. See either of the two spreadsheets referenced there to calculate the BETR for one's particular circumstances.

How did you answer the question in viewtopic.php?p=4819701#p4819701? Understand that may be helpful in understanding the BETR calculations.

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Re: Pay Roth conversion taxes with HSA funds?

Post by lstone19 » Sat Nov 02, 2019 11:03 pm

bandm wrote:
Sat Nov 02, 2019 9:26 pm
To me the break even tax rate is what is most relevant. Should I or should I not convert up to the top of the 24% bracket. The lower the break even tax rate is the clearer my crystal ball becomes about whether to do it or not. That’s why that is my focus and I’d like to see - if it exists - an extension of the Vanguard article specifically addressing the BETR with respect to this particular use of HSA money
You're ignoring the issue of what else you can do with the HSA money (in economics terms, the opportunity cost). You're seeing it as the HSA money is "cheap" money that can be used for things that don't make sense with more "expensive" money. Cash is cash. If you don't use the HSA money for this, then it's available for something else that would otherwise have to be paid (at some point later in life) with the more expensive money, That's why I said the source of the money is not relevant.

It's like finding a $20 bill on the ground and then saying I can afford to spend that $20 on something frivolous because the $20 was found money while saying you'd never spend $20 of earned money on that same thing. That type of thinking ignores that you could also save the money.

But hey - I'm a cruise ship right now. It's amazing how many people think of on-board spending credits that are offered with promotions as free money and use it to buy things they'd never buy with what they think of as their own money (the way that works is rather than spending, for example, $1,500 for a cruise, you spend $2,000 but get $500 in on-board credit you can use for just about anything on the ship). They still run up the same end of trip bill because they use the on-board credit for extras because they don't see themselves as the source of that money (rather than using it for their regular on-board expenses resulting in a smaller end of trip bill). They make different spending decision based on the perceived different source of funds. So back to the OP's question, if you think your source of funds is relevant, you're making the same mistake these cruisers make.

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Re: Pay Roth conversion taxes with HSA funds?

Post by birdog » Sun Nov 03, 2019 6:50 am

TravelforFun wrote:
Sat Nov 02, 2019 7:46 pm
HSA is the most valuable saving vehicle one could have. I'm keeping mine until the end to pay for my medical expenses in retirement. Also, how is it legal to withdraw HSA to pay for anything (in this case, taxes) other than medical expenses?

TravelforFun
This is my perspective as well. I want those HSA dollars to compound as long as possible. If I’m not using my HSA dollars now to pay for health care (which I’m not because my HSA account is the most valuable “retirement account” I have) then I’m not going to use that account to cover Roth conversion taxes now either.

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Re: Pay Roth conversion taxes with HSA funds?

Post by grabiner » Sun Nov 03, 2019 9:58 am

TravelforFun wrote:
Sat Nov 02, 2019 7:46 pm
HSA is the most valuable saving vehicle one could have. I'm keeping mine until the end to pay for my medical expenses in retirement. Also, how is it legal to withdraw HSA to pay for anything (in this case, taxes) other than medical expenses?
It is legal to use the HSA for any purpose, but withdrawals for non-medical purposes are taxable (and subject to a 20% penalty if you are under 65). Therefore, it is better to use the HSA for medical expenses.

But once you have the medical expenses, you can reimburse yourself from the HSA in a later year. If you have $10,000 of past medical expenses, you can withdraw $10,000 from the HSA this year as reimbursement for those medical expenses, deposit the $10,000 in your bank account and use it to pay a tax bill. Doing this is better than withdrawing $10,000 from a Roth IRA, or taking $10,000 more from a traditional IRA than the amount you wanted to convert from the Roth.

I agree that the HSA is the most valuable saving vehicle (and should be maxed out in preference to anything except a 401(k) with employer match), but you extracted that value when you made the contribution; it costs less out of pocket to put a dollar in an HSA than to put a dollar in a Roth IRA. Once the dollars are already there, it is better to have dollars in the Roth IRA.
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Re: Pay Roth conversion taxes with HSA funds?

Post by babystep » Sun Nov 03, 2019 10:46 am

Let us say one has
HSA=10k
tIRA=10k
Taxable=10k

option 1) Pay 2500 from HSA.
HSA=7500
tIRA=0
rIra=10k
Taxable=10k

option 2) Pay 2500 from taxable
HSA=10k
tIRA=0
rIra=10k
taxable=7500

1 year later, say each account grows by 10%.
option 1)
HSA=8250
rIra=11k
taxable=11k

option 2)
HSA=11k
rIra=11k
taxable=8250

One choose to keep more Roth dollars in option 2) vs option 1). The potential cost was they sold some from taxable and thereby may have incurred the tax on any gains which may not have happened when selling HSA.

One could think of this as paying the tax now vs later. Therefore, typical pay vs now analysis of future and current marginal tax rates may be considered.

If you are trying to pay the tax now then wouldn't you want to prefer the option 2) since it matches with pay the tax now ?

If one wants to avoid paying tax on $2500 then may be find $2500 from savings account, dividends in taxable, emergency funds etc.

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Re: Pay Roth conversion taxes with HSA funds?

Post by FiveK » Sun Nov 03, 2019 3:18 pm

babystep wrote:
Sun Nov 03, 2019 10:46 am
1 year later, say each account grows by 10%.
And, unless the growth in the taxable account is completely tax free for that year, the after-tax growth in that account will be less than 10%.

Differing growth in taxable vs. tax free is why the Break-Even Tax Rate (BETR) can be lower than the current marginal rate, as described in both the Vanguard and Bogleheads wiki articles.

lstone19
Posts: 460
Joined: Fri Nov 03, 2017 3:33 pm

Re: Pay Roth conversion taxes with HSA funds?

Post by lstone19 » Sun Nov 03, 2019 4:39 pm

Thinking about this some more, the OP is too focused on taxes paid on the money he's using rather than his overall tax picture. In investing, we talk about realized vs. unrealized gains. Similarly, we can talk about realized vs. unrealized taxes. The OP want to use the HSA money because the realized taxes on doing so will be zero. But in doing so, he leaves more unrealized and even more future unrealized taxes to have to deal with later.

The OP needs to get the money from the source that results in the smallest taxes across all transactions including those yet to occur in the future. And the way to do that is not to touch Roth/HSA* money until all other sources have been exhausted.

* That said, it can make sense to take out HSA money as part of what can best be described as a backdoor HSA to Roth conversion. If you're at the point where you need to take $X from a tIRA, instead convert $X from a tIRA to a Roth while taking $X from the HSA (assuming enough accrued medical expenses). You end up with the same combined Roth/HSA balance but more of it in Roth.

Miriam2
Posts: 2703
Joined: Fri Nov 14, 2014 11:51 am

Re: Pay Roth conversion taxes with HSA funds?

Post by Miriam2 » Mon Nov 04, 2019 12:22 pm

lstone19 wrote: Thinking about this some more, the OP is too focused on taxes paid on the money he's using rather than his overall tax picture. In investing, we talk about realized vs. unrealized gains. Similarly, we can talk about realized vs. unrealized taxes. The OP want to use the HSA money because the realized taxes on doing so will be zero. But in doing so, he leaves more unrealized and even more future unrealized taxes to have to deal with later.

The OP needs to get the money from the source that results in the smallest taxes across all transactions including those yet to occur in the future. And the way to do that is not to touch Roth/HSA* money until all other sources have been exhausted.

* That said, it can make sense to take out HSA money as part of what can best be described as a backdoor HSA to Roth conversion. If you're at the point where you need to take $X from a tIRA, instead convert $X from a tIRA to a Roth while taking $X from the HSA (assuming enough accrued medical expenses). You end up with the same combined Roth/HSA balance but more of it in Roth.
Yes, and then the OP is back to the initial conundrum -

Since they used HSA money to pay the Roth conversion tax, they used pre-tax and tax-free money for the tax. The tax-free money went from the HSA to the Roth and is still there for OP. That's good.

However, what about future medical bills? If OP has a medical expense the size of the tax taken out of the HSA (and there is no money left in the HSA to pay the medical bill) the OP will have to pay the medical bill out of a regular taxable account where the bill $ has been taxed at the highest income rate. So not sure any tax advantage was gained. Of course, if the HSA is large, then this might not matter.

ChrisC
Posts: 843
Joined: Tue Jun 19, 2012 9:10 am
Location: North Carolina

Re: Pay Roth conversion taxes with HSA funds?

Post by ChrisC » Mon Nov 04, 2019 1:58 pm

Miriam2 wrote:
Mon Nov 04, 2019 12:22 pm
lstone19 wrote: Thinking about this some more, the OP is too focused on taxes paid on the money he's using rather than his overall tax picture. In investing, we talk about realized vs. unrealized gains. Similarly, we can talk about realized vs. unrealized taxes. The OP want to use the HSA money because the realized taxes on doing so will be zero. But in doing so, he leaves more unrealized and even more future unrealized taxes to have to deal with later.

The OP needs to get the money from the source that results in the smallest taxes across all transactions including those yet to occur in the future. And the way to do that is not to touch Roth/HSA* money until all other sources have been exhausted.

* That said, it can make sense to take out HSA money as part of what can best be described as a backdoor HSA to Roth conversion. If you're at the point where you need to take $X from a tIRA, instead convert $X from a tIRA to a Roth while taking $X from the HSA (assuming enough accrued medical expenses). You end up with the same combined Roth/HSA balance but more of it in Roth.
Yes, and then the OP is back to the initial conundrum -

Since they used HSA money to pay the Roth conversion tax, they used pre-tax and tax-free money for the tax. The tax-free money went from the HSA to the Roth and is still there for OP. That's good.

However, what about future medical bills? If OP has a medical expense the size of the tax taken out of the HSA (and there is no money left in the HSA to pay the medical bill) the OP will have to pay the medical bill out of a regular taxable account where the bill $ has been taxed at the highest income rate. So not sure any tax advantage was gained. Of course, if the HSA is large, then this might not matter.
I'm confused by this entire thread, and I would never take money out of my HSA (from medical expense reimbursement) to add to my Roth (because I decided not to pay taxes on a conversion from a taxable account like my checking account or from additional withholding from wages or a pension). Sounds like a lot of mental accounting that doesn't add up -- this doesn't increase tax deferred savings -- all it does to me, is shave a little bit off your tax liability from the conversion in some cases -- in my case, it doesn't do anything to me because I can withhold enough from my pension or current part-time earnings to pay for the conversion tax or I have a cash position that would take care of the liability and not losing any opportunity costs).

Nonetheless, I have thought about reimbursing medical expenses from my HSA and then using those funds for Roth contributions for my wife and I. I have enough part-time income to make maximum Roth contributions for my wife and I. I really don't need to add to my Roth accounts at this stage of my life, as conversions for us will do the trick as we convert deep into the 24% bracket. However, in looking at this issue, I realize that with the level of Roth conversions we currently do -- and with our pensions and part-time income -- we are beyond the income levels for Roth contributions.

I think these exercises, including mine and the OP's, spin a lot of wheels.

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