Does this HSA long term strategy make sense? (And relative unimportance of keeping receipts before age 65)

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Counterpoint
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Does this HSA long term strategy make sense? (And relative unimportance of keeping receipts before age 65)

Post by Counterpoint » Sat Dec 07, 2019 3:40 pm

This post is to request inputs on whether the long-term HSA planning parameters outlined below make sense, and on what I may be missing.

I’m helping some younger family members with their financial planning. In particular, there is a couple I’m helping who have little bandwidth for detailed financial planning given busy jobs, young kids and some significant family health challenges. 2019 is their first year with HSAs (they are both around 30). They’re lucky to have stable medical jobs where they both max out their retirement accounts: 401Ks and backdoor individual Roth IRAs. So as suggested in the BH HSA Wiki, they are planning to pay their health care expenses out of pocket and invest their HSAs (also maxed out for the combined $7K) as a health care retirement account for when they reach 65. HSA balances are invested aggressively since they will likely not tap the account for 35+ years.

Below are some projections that I think help clarify how the HSA could be used over the long term:

- The assumption is that they would continue maxing out their HSA as long as they belong to a high deductible health plan (HDHP), and would only invest all the proceeds (i.e. pay all health care expenses out of pocket) till age 65.

- If I assume they will belong to an HDHP for two-thirds of their years from now till age 65, and max out their HSA for all of those years, their HSA balance at age 65 would likely be several hundred thousand dollars (in 2019 $). If they get real returns of 5% on their portfolio, the HSA balance will be around $450K at age 65 (in real dollars, i.e. 2019 $). If real returns are only 3.5% over the next 35 years, the HSA balance would be $325K; conversely if real returns were 6.5% (the historical stock market average), the HSA balance would be $925K.

- Estimates of average lifetime healthcare expenses starting age 65 are of a similar order of magnitude (several hundred thousand dollars): Fidelity estimated it at around $400K including long term care according to this Forbes article https://www.forbes.com/sites/howardglec ... f76b6078e2

- So there seems to be a decent chance they may use up a good chunk of the accumulated HSA balances. But if they don’t it could go to their heirs (who would immediately pay taxes on the inherited HSA amount). So in that case the after-tax economics would have been similar to them investing in and bequeathing a traditional IRA. (With some differences: With the HSA there are no RMDs, but there’s also no stretch IRA possibility for the heirs.)

- If they are able to keep receipts for at least their larger health care expenses over the next 35 years, they have the additional option of disbursing from their HSAs based on these receipts. They can decide later whether or not to take disbursements based on their tax and other financial circumstances at that point. But what was interesting to me is that the amount reimbursable is only a fraction of the likely HSA balance: The amount reimbursable would be about $110K in today's dollars (assuming documented medical expenses of $5K pa in 2019 $ over the next 35 years, and then discounting the total at age 65 at a 3% pa inflation rate).

- While the $110K of potential reimbursement is not insignificant, it is still a relatively small fraction of the projected HSA balance of several hundred thousand dollars. So even if they don’t keep a single receipt till age 65 and hence have no reimbursable expenses at age 65, it would still make sense for them to use the HSA as described.

- If they keep receipts they could also tap into the HSA before 65 on an emergency basis (although they do have an emergency fund already, and a very good start to their savings). But again, the amount is not that large: the $110K is reached only at age 65, and if they have an emergency need at say age 50, the amount in the HSA would be around $60K: Nice to have, but not that significant in the context of their financial situation.

Any thoughts on the above?

And in particular on my estimate of the relatively low impact of maintaining receipts (at least given this couple’s financial situation)? This was surprising to me, since I've read posts by people thinking of using HSAs as long-term medical retirement accounts, who are turned off by the prospect of record-keeping. But at least in the above situation, keeping receipts for the next 35 years does not really appear to be essential to get most of the benefits of the HSA as a long term investment strategy.

Of course they would need to keep receipts once they hit 65 and need to withdraw funds from the HSA. And in reality I hope they would be able to maintain receipts for larger expenses over the next 35 years, but I’m examining the extreme case of “no receipts till 65” in order to gain some clarity of thinking. I’ve read several BH threads already with suggestions on how to maintain receipts most easily for the long term, so I would respectfully request replies to not duplicate that particular discussion.

Thanks!

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Svensk Anga
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Re: Does this HSA long term strategy make sense? (And relative unimportance of keeping receipts before age 65)

Post by Svensk Anga » Sat Dec 07, 2019 6:51 pm

If they are saving that well, I doubt they will work and stash in the HSA till 65.

I would suggest saving at least the receipts above $X, where X is a compromise between record keeping hassle and maximizing tax-free access. The couple gets to decide what X is. With that much HSA potential, I think they would want to keep open the option of making a tax-free withdrawal some years down the road if they are in a tight spot, or maybe just in early retirement. Living on the HSA could enable some cheap Roth conversion for instance.

Chances of the health care/regulatory/tax regime staying consistent for 35 years looks like nil. Best to keep their options open.

jebmke
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Re: Does this HSA long term strategy make sense? (And relative unimportance of keeping receipts before age 65)

Post by jebmke » Sat Dec 07, 2019 6:58 pm

Our regular providers will produce an annual statement when I request it in January. The pharmacy statements are available online. But normally for the docs I have to request it. The statement lists all the individual items, what was paid by insurance, payments by me and a net account balance of zero at December 31. That covers most of our cost now. So I don't really keep a receipt for an individual item except for one-offs like glasses.

I decided a while ago to reimburse annually rather than save receipts long term. But I still simplify things with the annual statements.
When you discover that you are riding a dead horse, the best strategy is to dismount.

curmudgeon
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Re: Does this HSA long term strategy make sense? (And relative unimportance of keeping receipts before age 65)

Post by curmudgeon » Sat Dec 07, 2019 7:17 pm

Whatever path they take should recognize that flexibility is very valuable. It's highly unlikely that tax laws will remain stable over the next 35 years. Without getting into the politics too much, it's certainly possible that HSAs may end up "orphaned" (at best) sometime in the future. Lots of other changes are possible as well; 10 years ago I wouldn't have expected that there would be so much value in managing our income under an arbitrary "400% FPL" limit, but it gives us a subsidy of almost $20K per year to do so now. Saving receipts for HSA reimbursement later gives you the possibility of access to a chunk of cash which is largely off the financial radar screen (probably even more so than Roth accounts).

For myself, I started out with that "save receipts and draw later" model in mind, but I decided it wasn't really worthwhile. There's just enough messiness to the process, and I know how records (digital or physical) deteriorate over time. I now draw out the expenses once a year (though you could also do it at time or service via the debit card thing). The money drawn is invested in a tax-efficient index fund.

There's a non-trivial chance that both might die before the HSA is seriously drawn down, and then it would become rather a tax bomb of large ordinary income to the heirs. If the medical expense amounts had instead been invested in index funds over the years, then they would pass on with a stepped up basis instead.

In my case we've only had an HSA for a few years, with a few more to go until Medicare age. If we remain fortunate with good health ($9K contributions, $1-2K expenses) we may hit $100K in the HSA before we can no longer contribute. At that point I plan to try to draw it down (on medicare premiums and qualified expenses) as quickly as they occur. I'd much prefer to leave Roths to our kids rather than an HSA.

aristotelian
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Re: Does this HSA long term strategy make sense? (And relative unimportance of keeping receipts before age 65)

Post by aristotelian » Sun Dec 08, 2019 7:19 am

Bottom line, they should max it out and invest it for now. If at some point in the distant future they are worried that they will never spend it, they can reconsider. Between long term care insurance and Medicare premiums I doubt that will ever be the case. Even in that case, they can use it as additional 401k space.

Topic Author
Counterpoint
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Re: Does this HSA long term strategy make sense? (And relative unimportance of keeping receipts before age 65)

Post by Counterpoint » Sun Dec 08, 2019 3:46 pm

Thanks for all the comments.
Svensk Anga wrote:
Sat Dec 07, 2019 6:51 pm
If they are saving that well, I doubt they will work and stash in the HSA till 65.
Good point. Their vague target is to try and retire at 60 - or at least go part time. But even if they stop contributing to their HSAs at 60, it does not affect the projected HSA balance much, since most of the returns on the HSA portfolio by then come from investment returns and not new contributions. For instance, in the 5% return scenario, it would reduce the $450K projected HSA balance by only $40K.

Svensk Anga wrote:
Sat Dec 07, 2019 6:51 pm
I would suggest saving at least the receipts above $X, where X is a compromise between record keeping hassle and maximizing tax-free access. The couple gets to decide what X is. With that much HSA potential, I think they would want to keep open the option of making a tax-free withdrawal some years down the road if they are in a tight spot, or maybe just in early retirement. Living on the HSA could enable some cheap Roth conversion for instance.

Chances of the health care/regulatory/tax regime staying consistent for 35 years looks like nil. Best to keep their options open.

Agree on the benefit of keeping options open by maintaining receipts (at least whatever can be done easily).
jebmke wrote:
Sat Dec 07, 2019 6:58 pm
Our regular providers will produce an annual statement when I request it in January. The pharmacy statements are available online. But normally for the docs I have to request it. The statement lists all the individual items, what was paid by insurance, payments by me and a net account balance of zero at December 31. That covers most of our cost now. So I don't really keep a receipt for an individual item except for one-offs like glasses.

I decided a while ago to reimburse annually rather than save receipts long term. But I still simplify things with the annual statements.
My apologies: When I used the word “receipts”, I was generically referring to all kids of documentation for tax purposes, including EOBs or other provider statements. I’m planning to post a separate thread on my thoughts re: the type of documentation that would be sufficient.

curmudgeon wrote:
Sat Dec 07, 2019 7:17 pm
For myself, I started out with that "save receipts and draw later" model in mind, but I decided it wasn't really worthwhile. There's just enough messiness to the process, and I know how records (digital or physical) deteriorate over time. I now draw out the expenses once a year (though you could also do it at time or service via the debit card thing). The money drawn is invested in a tax-efficient index fund.

There's a non-trivial chance that both might die before the HSA is seriously drawn down, and then it would become rather a tax bomb of large ordinary income to the heirs. If the medical expense amounts had instead been invested in index funds over the years, then they would pass on with a stepped up basis instead.
Interesting point on inheritance taxes. There is clearly a benefit at inheritance by way of the step-up tax basis if the money had been moved out of the HSA and then reinvested in taxable index funds. But I believe for the couple at this stage, that is a secondary objective. The primary objective is to make sure the couple have enough for their medical (and other) expenses in retirement, and are not a burden on their kids financially if they end up living a long life and having significant long term care expenses. (The joint life expectancy for a 50-year old couple - i.e. when the second of them is expected to die - is now over 90.)

So I did a projection of the possible difference in outcomes during their lifetimes, and it is significant over long periods: If the couple contributes $7K pa each year through age 60, then at age 70 the HSA balance at a 5% real return would be $800K in today’s dollars. If the same amounts are put into the HSA and immediately moved into taxable index funds with a tax drag of 0.5% (e.g. VTSAX), the after-tax amount at age 70 would be $600K. The gap is substantial enough that even if taxes were ultimately paid on HSA amounts (either if a significant portion of the HSA were used for non-medical expenses, or if passed on as an inheritance), the alternative of keeping money in the HSA would likely come out ahead. But more importantly, there would a substantial extra cushion during retirement to allay fears about longevity risk and crippling long term care expenses.
(Note: For simplicity I assumed yearly contributions in this example, rather than contributions for 2/3 of their years as in the earlier post.)

Nevertheless, when they are older the couple could always reassess the trade-off between this extra return during their lifetime versus the step-up basis benefit for inheritance, and perhaps indeed disburse from the HSA to move some funds into a taxable index fund (which of course maintaining receipts would enable - underlying your point and Svensk Anga’s of the value of flexibility). But again, the impact is relatively limited: They are only likely to do this if they are very comfortably ahead of the retirement game due to high investment returns, in which case the HSA is likely to be of the order of $1MM. In comparison, the tax savings from using the accumulated receipts would only be about $35K (on the reimbursed amount of $110K). In the big picture for them, the receipts are not particularly important.
Last edited by Counterpoint on Sun Dec 08, 2019 4:54 pm, edited 1 time in total.

Topic Author
Counterpoint
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Joined: Sun Jun 05, 2016 1:42 pm

Re: Does this HSA long term strategy make sense? (And relative unimportance of keeping receipts before age 65)

Post by Counterpoint » Sun Dec 08, 2019 4:00 pm

aristotelian wrote:
Sun Dec 08, 2019 7:19 am
Bottom line, they should max it out and invest it for now. If at some point in the distant future they are worried that they will never spend it, they can reconsider. Between long term care insurance and Medicare premiums I doubt that will ever be the case. Even in that case, they can use it as additional 401k space.
:thumbsup

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