Does it make sense to intentionally overfund HSA?

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CletusCaddy
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Does it make sense to intentionally overfund HSA?

Post by CletusCaddy »

Let’s assume the following:

1. You intentionally fund two HSAs to the maximum every year for 30 years. Let’s assume both spouses have access to HSAs.
2. HSA limits increase by 2% every year.
3. You are in 35% tax bracket every year.
4. Excise tax on cumulative excess contribution is 6% every year.
5. 10% CAGR on invested money

Keep all figures nominal.

Under this scenario my spreadsheet tells me that by the end of year 30, my excess HSA account will reach an ending amount of $1.43M. Over the 30 years I will have paid cumulative income taxes of $104k and penalties of $249k. Net net, I end up with $1.07M post tax post penalty. At this point I withdraw all of the cumulative excess contributions to stop the penalty.

If I had invested that excess HSA money (post tax) into taxable instead, I would have ended up with $0.93M, most of which is capital gains.

Can someone confirm my math? Is this a hidden tax opportunity under all of our noses?
Running Bum
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Re: Does it make sense to intentionally overfund HSA?

Post by Running Bum »

I don't know about your numbers, but to withdraw this money tax free, you'd need $1.43M in allowable medical expenses. How likely is that for you?

Anything short of that $1.43M is like contributing to a tIRA, and I doubt paying a penalty on that comes out better.

Furthermore, when you (and your spouse) die, I think any excess you leave must be withdrawn that year by your heirs and is fully taxed as ordinary income. That's worse than inheriting a tIRA, and much worse than inheriting a taxable account with unrecognized cap gains.

Is it really worth confirming your math?
runninginvestor
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Re: Does it make sense to intentionally overfund HSA?

Post by runninginvestor »

Out of curiosity, how would it play out if someone died with excess contributions. Say you're married and your spouse ingerits the account. Do they inherit the tax consequences of excess contributions?
AnEngineer
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Let’s assume the following:

1. You intentionally fund two HSAs to the maximum every year for 30 years. Let’s assume both spouses have access to HSAs.
2. HSA limits increase by 2% every year.
3. You are in 35% tax bracket every year.
4. Excise tax on cumulative excess contribution is 6% every year.
5. 10% CAGR on invested money

Keep all figures nominal.

Under this scenario my spreadsheet tells me that by the end of year 30, my excess HSA account will reach an ending amount of $1.43M. Over the 30 years I will have paid cumulative income taxes of $104k and penalties of $249k. Net net, I end up with $1.07M post tax post penalty. At this point I withdraw all of the cumulative excess contributions to stop the penalty.

If I had invested that excess HSA money (post tax) into taxable instead, I would have ended up with $0.93M, most of which is capital gains.

Can someone confirm my math? Is this a hidden tax opportunity under all of our noses?
Can you post more details of what's going into your math? Since you mention the 6% excise tax, I assume by excess you mean in excess of the allowed limits. You know in that case that you don't get to deduct the contributions, right? So the only benefit is deferring taxes, but you're paying a 6% tax every year to do it and may pay taxes on the withdrawals with such a high balance, or even anyways. I know if you withdraw excess HSA contributions early enough to avoid the penalty you include the earnings as regular income in the year you receive them. I'm skeptical that you can come out ahead.
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CletusCaddy
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Re: Does it make sense to intentionally overfund HSA?

Post by CletusCaddy »

AnEngineer wrote: Wed Aug 03, 2022 8:49 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Let’s assume the following:

1. You intentionally fund two HSAs to the maximum every year for 30 years. Let’s assume both spouses have access to HSAs.
2. HSA limits increase by 2% every year.
3. You are in 35% tax bracket every year.
4. Excise tax on cumulative excess contribution is 6% every year.
5. 10% CAGR on invested money

Keep all figures nominal.

Under this scenario my spreadsheet tells me that by the end of year 30, my excess HSA account will reach an ending amount of $1.43M. Over the 30 years I will have paid cumulative income taxes of $104k and penalties of $249k. Net net, I end up with $1.07M post tax post penalty. At this point I withdraw all of the cumulative excess contributions to stop the penalty.

If I had invested that excess HSA money (post tax) into taxable instead, I would have ended up with $0.93M, most of which is capital gains.

Can someone confirm my math? Is this a hidden tax opportunity under all of our noses?
Can you post more details of what's going into your math? Since you mention the 6% excise tax, I assume by excess you mean in excess of the allowed limits. You know in that case that you don't get to deduct the contributions, right? So the only benefit is deferring taxes, but you're paying a 6% tax every year to do it and may pay taxes on the withdrawals with such a high balance, or even anyways. I know if you withdraw excess HSA contributions early enough to avoid the penalty you include the earnings as regular income in the year you receive them. I'm skeptical that you can come out ahead.
The only benefit is not just deferring taxes, the much bigger benefit is the compounding that occurs within the HSA account, which appears to outweigh the drag of the excise tax and the income tax on contributions.

Simplifying it down, I am paying 41 cents in taxes on every excess contributed dollar at the moment of contribution, but those 41 contributed cents get to stay in the account and compound.
Topic Author
CletusCaddy
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Re: Does it make sense to intentionally overfund HSA?

Post by CletusCaddy »

Running Bum wrote: Wed Aug 03, 2022 7:21 am I don't know about your numbers, but to withdraw this money tax free, you'd need $1.43M in allowable medical expenses. How likely is that for you?

Anything short of that $1.43M is like contributing to a tIRA, and I doubt paying a penalty on that comes out better.

Furthermore, when you (and your spouse) die, I think any excess you leave must be withdrawn that year by your heirs and is fully taxed as ordinary income. That's worse than inheriting a tIRA, and much worse than inheriting a taxable account with unrecognized cap gains.

Is it really worth confirming your math?
So in this scenario we would have two HSAs, one of which is the “excess” account. So we would end up with $2.86M in HSAs. But that is a nominal figure, everything I’ve read is that medical inflation outpaces ordinary CPI. And also there are a lot of high priced health items one encounters into retirement. With a huge account like this we would be able to afford the best of the best assisted care. Finally, if I actually do this, I’ll start saving all medical related receipts for the next 30 years to make an even bigger dent in the balance once I hit 65
Last edited by CletusCaddy on Wed Aug 03, 2022 9:19 am, edited 1 time in total.
AnEngineer
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

CletusCaddy wrote: Wed Aug 03, 2022 9:15 am
AnEngineer wrote: Wed Aug 03, 2022 8:49 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Let’s assume the following:

1. You intentionally fund two HSAs to the maximum every year for 30 years. Let’s assume both spouses have access to HSAs.
2. HSA limits increase by 2% every year.
3. You are in 35% tax bracket every year.
4. Excise tax on cumulative excess contribution is 6% every year.
5. 10% CAGR on invested money

Keep all figures nominal.

Under this scenario my spreadsheet tells me that by the end of year 30, my excess HSA account will reach an ending amount of $1.43M. Over the 30 years I will have paid cumulative income taxes of $104k and penalties of $249k. Net net, I end up with $1.07M post tax post penalty. At this point I withdraw all of the cumulative excess contributions to stop the penalty.

If I had invested that excess HSA money (post tax) into taxable instead, I would have ended up with $0.93M, most of which is capital gains.

Can someone confirm my math? Is this a hidden tax opportunity under all of our noses?
Can you post more details of what's going into your math? Since you mention the 6% excise tax, I assume by excess you mean in excess of the allowed limits. You know in that case that you don't get to deduct the contributions, right? So the only benefit is deferring taxes, but you're paying a 6% tax every year to do it and may pay taxes on the withdrawals with such a high balance, or even anyways. I know if you withdraw excess HSA contributions early enough to avoid the penalty you include the earnings as regular income in the year you receive them. I'm skeptical that you can come out ahead.
The only benefit is not just deferring taxes, the much bigger benefit is the compounding that occurs within the HSA account, which appears to outweigh the drag of the excise tax and the income tax on contributions.

Simplifying it down, I am paying 41 cents in taxes on every excess contributed dollar at the moment of contribution, but those 41 contributed cents get to stay in the account and compound.
That's the deferral I'm talking about, you defer taxes on the gains (and can adjust investments without a taxable event).
tonyclifton
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Re: Does it make sense to intentionally overfund HSA?

Post by tonyclifton »

Why not just invest in taxable so you can do whatever you want with the money? Or over buy I/EE bonds if you want a little more tax deferred space with less restrictions and compounding. 529 is another option. Millions (or even half a million) in HSA with restrictions doesn’t seem like an optimal outcome.
H-Town
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Re: Does it make sense to intentionally overfund HSA?

Post by H-Town »

CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Let’s assume the following:

1. You intentionally fund two HSAs to the maximum every year for 30 years. Let’s assume both spouses have access to HSAs.
2. HSA limits increase by 2% every year.
3. You are in 35% tax bracket every year.
4. Excise tax on cumulative excess contribution is 6% every year.
5. 10% CAGR on invested money

Keep all figures nominal.

Under this scenario my spreadsheet tells me that by the end of year 30, my excess HSA account will reach an ending amount of $1.43M. Over the 30 years I will have paid cumulative income taxes of $104k and penalties of $249k. Net net, I end up with $1.07M post tax post penalty. At this point I withdraw all of the cumulative excess contributions to stop the penalty.

If I had invested that excess HSA money (post tax) into taxable instead, I would have ended up with $0.93M, most of which is capital gains.

Can someone confirm my math? Is this a hidden tax opportunity under all of our noses?
This sounds like you borrow money from Joe at 6% and then lend to Bob for 10% and profit on the rate difference. It could work for a year, i.e. short-term, but it will likely not work for 30 years. Do you think 6% excise tax on excess contribution is written in stone? Do you think 10% CAGR is a guaranteed regardless of changes to macro factors? The IRS will change the rate on any given year if the penalty/excise tax does not do its job to discourage people from overcontribute their HSA.
Time is the ultimate currency.
Topic Author
CletusCaddy
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Re: Does it make sense to intentionally overfund HSA?

Post by CletusCaddy »

H-Town wrote: Wed Aug 03, 2022 9:35 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Let’s assume the following:

1. You intentionally fund two HSAs to the maximum every year for 30 years. Let’s assume both spouses have access to HSAs.
2. HSA limits increase by 2% every year.
3. You are in 35% tax bracket every year.
4. Excise tax on cumulative excess contribution is 6% every year.
5. 10% CAGR on invested money

Keep all figures nominal.

Under this scenario my spreadsheet tells me that by the end of year 30, my excess HSA account will reach an ending amount of $1.43M. Over the 30 years I will have paid cumulative income taxes of $104k and penalties of $249k. Net net, I end up with $1.07M post tax post penalty. At this point I withdraw all of the cumulative excess contributions to stop the penalty.

If I had invested that excess HSA money (post tax) into taxable instead, I would have ended up with $0.93M, most of which is capital gains.

Can someone confirm my math? Is this a hidden tax opportunity under all of our noses?
This sounds like you borrow money from Joe at 6% and then lend to Bob for 10% and profit on the rate difference. It could work for a year, i.e. short-term, but it will likely not work for 30 years. Do you think 6% excise tax on excess contribution is written in stone? Do you think 10% CAGR is a guaranteed regardless of changes to macro factors? The IRS will change the rate on any given year if the penalty/excise tax does not do its job to discourage people from overcontribute their HSA.
So what you’re saying is, it works, but I should probably delete this thread so it doesn’t become too popular?
AnEngineer
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Can someone confirm my math?
Can you clarify how you're using your numbers? I'm not finding the same values.
H-Town
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Re: Does it make sense to intentionally overfund HSA?

Post by H-Town »

CletusCaddy wrote: Wed Aug 03, 2022 9:42 am
H-Town wrote: Wed Aug 03, 2022 9:35 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Let’s assume the following:

1. You intentionally fund two HSAs to the maximum every year for 30 years. Let’s assume both spouses have access to HSAs.
2. HSA limits increase by 2% every year.
3. You are in 35% tax bracket every year.
4. Excise tax on cumulative excess contribution is 6% every year.
5. 10% CAGR on invested money

Keep all figures nominal.

Under this scenario my spreadsheet tells me that by the end of year 30, my excess HSA account will reach an ending amount of $1.43M. Over the 30 years I will have paid cumulative income taxes of $104k and penalties of $249k. Net net, I end up with $1.07M post tax post penalty. At this point I withdraw all of the cumulative excess contributions to stop the penalty.

If I had invested that excess HSA money (post tax) into taxable instead, I would have ended up with $0.93M, most of which is capital gains.

Can someone confirm my math? Is this a hidden tax opportunity under all of our noses?
This sounds like you borrow money from Joe at 6% and then lend to Bob for 10% and profit on the rate difference. It could work for a year, i.e. short-term, but it will likely not work for 30 years. Do you think 6% excise tax on excess contribution is written in stone? Do you think 10% CAGR is a guaranteed regardless of changes to macro factors? The IRS will change the rate on any given year if the penalty/excise tax does not do its job to discourage people from overcontribute their HSA.
So what you’re saying is, it works, but I should probably delete this thread so it doesn’t become too popular?
I'd say go for it. If it doesn't go well for you for a few years, you can withdraw the excess and pay the excise tax. If it goes well, you should get the some profit.

I will just invest in taxable account in stock index funds, which are very tax efficient. There are tools that I can manage capital gain in the future such as capital loss carryover from TLH, tax gain harvesting during the years that we retire early, etc. I may get close to 8-9% CAGR with taxable investment and don't have to pay 6% excise tax if I were to invest the excess HSA contribution.
Time is the ultimate currency.
petulant
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Re: Does it make sense to intentionally overfund HSA?

Post by petulant »

It is a sound idea that the excise tax of 6% can be beaten by compounding since the tax is only owed on the original contribution, not the whole account. But the tax drag of a 6% excise tax on original excess contributions will greatly exceed the tax drag on dividends from a stock index fund. For example, an initial investment of $100 might produce annual dividends of $1.60, which even at a tax rate of 30% would only be $.48, much less than $6. With compounding of the original $100, it takes until year 28 for the dividend tax drag to exceed $6. If OP's math is showing an excess HSA contribution beating a taxable account, something is wrong in the math. For example, it could be that the deductible, legal HSAs are being mixed with the excess HSAs in the math, which is incorrect; or that the chosen benchmark of comparing ending values is hiding a problem like the source of funds for the 6% excise tax while paying stock tax drag out of account balance; or that the basis of the stock account has not been increased owing to dividend reinvestment. If the calculations are performed correctly, the IRR on the aftertax value of the taxable stock should beat the IRR on the pretax balance of the HSA.
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CletusCaddy
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Re: Does it make sense to intentionally overfund HSA?

Post by CletusCaddy »

AnEngineer wrote: Wed Aug 03, 2022 9:48 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Can someone confirm my math?
Can you clarify how you're using your numbers? I'm not finding the same values.
Here is the spreadsheet:
https://docs.google.com/spreadsheets/d/ ... sp=sharing

I'm not convinced this is correct. The biggest question I have is whether on the Excess HSA side I should be accounting for the opportunity cost of lost gains on the excise tax being paid every year. Right now the model ignores this.
AnEngineer
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

CletusCaddy wrote: Wed Aug 03, 2022 11:15 am
AnEngineer wrote: Wed Aug 03, 2022 9:48 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Can someone confirm my math?
Can you clarify how you're using your numbers? I'm not finding the same values.
Here is the spreadsheet:
https://docs.google.com/spreadsheets/d/ ... sp=sharing

I'm not convinced this is correct. The biggest question I have is whether on the Excess HSA side I should be accounting for the opportunity cost of lost gains on the excise tax being paid every year. Right now the model ignores this.
The biggest error I see is that your taxable comparison point assumes that you have to pay more taxes. You don't get to deduct excess HSA contributions on your income. You pay the same income taxes up front in both cases.
02nz
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Re: Does it make sense to intentionally overfund HSA?

Post by 02nz »

OP, seems like you should do this and let us know how it goes. :happy
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Re: Does it make sense to intentionally overfund HSA?

Post by 02nz »

AnEngineer wrote: Wed Aug 03, 2022 11:20 am
CletusCaddy wrote: Wed Aug 03, 2022 11:15 am
AnEngineer wrote: Wed Aug 03, 2022 9:48 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Can someone confirm my math?
Can you clarify how you're using your numbers? I'm not finding the same values.
Here is the spreadsheet:
https://docs.google.com/spreadsheets/d/ ... sp=sharing

I'm not convinced this is correct. The biggest question I have is whether on the Excess HSA side I should be accounting for the opportunity cost of lost gains on the excise tax being paid every year. Right now the model ignores this.
The biggest error I see is that your taxable comparison point assumes that you have to pay more taxes. You don't get to deduct excess HSA contributions on your income. You pay the same income taxes up front in both cases.
So the "overfunded" HSA is basically a nondeductible tIRA with a fee of 6% of original contributions every year, unless it can actually be used for medical expenses? That doesn't seem likely to work out very well.
Last edited by 02nz on Wed Aug 03, 2022 11:32 am, edited 1 time in total.
Kookaburra
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Re: Does it make sense to intentionally overfund HSA?

Post by Kookaburra »

Go for it and let us know how it goes.
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CletusCaddy
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Re: Does it make sense to intentionally overfund HSA?

Post by CletusCaddy »

02nz wrote: Wed Aug 03, 2022 11:26 am OP, seems like you should do this and let us know how it goes. :happy
I can’t “let you know how it goes” if I don’t have my model set up correctly which right now I don’t think it is
02nz
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Re: Does it make sense to intentionally overfund HSA?

Post by 02nz »

CletusCaddy wrote: Wed Aug 03, 2022 11:32 am
02nz wrote: Wed Aug 03, 2022 11:26 am OP, seems like you should do this and let us know how it goes. :happy
I can’t “let you know how it goes” if I don’t have my model set up correctly which right now I don’t think it is
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02nz
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Re: Does it make sense to intentionally overfund HSA?

Post by 02nz »

Running Bum wrote: Wed Aug 03, 2022 7:21 am I don't know about your numbers, but to withdraw this money tax free, you'd need $1.43M in allowable medical expenses. How likely is that for you?
Well, at the rate medical costs are going up in this country ...
AnEngineer
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

02nz wrote: Wed Aug 03, 2022 11:28 am
AnEngineer wrote: Wed Aug 03, 2022 11:20 am
CletusCaddy wrote: Wed Aug 03, 2022 11:15 am
AnEngineer wrote: Wed Aug 03, 2022 9:48 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Can someone confirm my math?
Can you clarify how you're using your numbers? I'm not finding the same values.
Here is the spreadsheet:
https://docs.google.com/spreadsheets/d/ ... sp=sharing

I'm not convinced this is correct. The biggest question I have is whether on the Excess HSA side I should be accounting for the opportunity cost of lost gains on the excise tax being paid every year. Right now the model ignores this.
The biggest error I see is that your taxable comparison point assumes that you have to pay more taxes. You don't get to deduct excess HSA contributions on your income. You pay the same income taxes up front in both cases.
So the "overfunded" HSA is basically a nondeductible tIRA with a fee of 6% of original contributions every year, unless it can actually be used for medical expenses? That doesn't seem likely to work out very well.
Yes.
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CletusCaddy
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Re: Does it make sense to intentionally overfund HSA?

Post by CletusCaddy »

petulant wrote: Wed Aug 03, 2022 11:01 am It is a sound idea that the excise tax of 6% can be beaten by compounding since the tax is only owed on the original contribution, not the whole account. But the tax drag of a 6% excise tax on original excess contributions will greatly exceed the tax drag on dividends from a stock index fund. For example, an initial investment of $100 might produce annual dividends of $1.60, which even at a tax rate of 30% would only be $.48, much less than $6. With compounding of the original $100, it takes until year 28 for the dividend tax drag to exceed $6. If OP's math is showing an excess HSA contribution beating a taxable account, something is wrong in the math. For example, it could be that the deductible, legal HSAs are being mixed with the excess HSAs in the math, which is incorrect; or that the chosen benchmark of comparing ending values is hiding a problem like the source of funds for the 6% excise tax while paying stock tax drag out of account balance; or that the basis of the stock account has not been increased owing to dividend reinvestment. If the calculations are performed correctly, the IRR on the aftertax value of the taxable stock should beat the IRR on the pretax balance of the HSA.
I think the bolded part is where I am going wrong. If I account for the forgone market gains on the excise tax, that eats into the excess HSA balance significantly, bringing it below the taxable account.
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Re: Does it make sense to intentionally overfund HSA?

Post by LadyGeek »

I want to address several comments related to intentionally overfunding a Health savings account. For the record, discussions of dishonest behavior or bypassing the law are totally unacceptable.

The intent is to understand how to do this within the existing legal framework; in which case this discussion can continue.

Everything is a matter of degree. The choice of using a tax deferred account, e.g. IRA, to avoid taxes during some period of time is one extreme, managing assets to qualify for Medicaid is the other. Gifting assets to avoid taxes is somewhere in the middle. The bottom line is to work within the legal framework. Ethics is the ever present elephant in the room.

Holding multiple HSAs is permitted. IRS Publication 969 (2021), Health Savings Accounts and Other Tax-Favored Health Plans describes the penalties for excess contributions, of which the OP is willing to pay.
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petulant
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Re: Does it make sense to intentionally overfund HSA?

Post by petulant »

CletusCaddy wrote: Wed Aug 03, 2022 11:42 am
petulant wrote: Wed Aug 03, 2022 11:01 am It is a sound idea that the excise tax of 6% can be beaten by compounding since the tax is only owed on the original contribution, not the whole account. But the tax drag of a 6% excise tax on original excess contributions will greatly exceed the tax drag on dividends from a stock index fund. For example, an initial investment of $100 might produce annual dividends of $1.60, which even at a tax rate of 30% would only be $.48, much less than $6. With compounding of the original $100, it takes until year 28 for the dividend tax drag to exceed $6. If OP's math is showing an excess HSA contribution beating a taxable account, something is wrong in the math. For example, it could be that the deductible, legal HSAs are being mixed with the excess HSAs in the math, which is incorrect; or that the chosen benchmark of comparing ending values is hiding a problem like the source of funds for the 6% excise tax while paying stock tax drag out of account balance; or that the basis of the stock account has not been increased owing to dividend reinvestment. If the calculations are performed correctly, the IRR on the aftertax value of the taxable stock should beat the IRR on the pretax balance of the HSA.
I think the bolded part is where I am going wrong. If I account for the forgone market gains on the excise tax, that eats into the excess HSA balance significantly, bringing it below the taxable account.
I agree you have a source-of-funds or opportunity cost problem for the excise tax amount each year. You also appear to be assuming that the excess HSA contributions are still tax deductible, so you're comparing the full excess contribution to a taxable brokerage account less income taxes paid. I do not believe this is correct. If you review Form 8889 and its instructions closely, I believe you will find that you are only allowed to take a deduction for the maximum annual contribution of $7300 or so.

https://www.irs.gov/pub/irs-pdf/f8889.pdf
https://www.irs.gov/instructions/i8889
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CletusCaddy
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Re: Does it make sense to intentionally overfund HSA?

Post by CletusCaddy »

petulant wrote: Wed Aug 03, 2022 11:58 am
CletusCaddy wrote: Wed Aug 03, 2022 11:42 am
petulant wrote: Wed Aug 03, 2022 11:01 am It is a sound idea that the excise tax of 6% can be beaten by compounding since the tax is only owed on the original contribution, not the whole account. But the tax drag of a 6% excise tax on original excess contributions will greatly exceed the tax drag on dividends from a stock index fund. For example, an initial investment of $100 might produce annual dividends of $1.60, which even at a tax rate of 30% would only be $.48, much less than $6. With compounding of the original $100, it takes until year 28 for the dividend tax drag to exceed $6. If OP's math is showing an excess HSA contribution beating a taxable account, something is wrong in the math. For example, it could be that the deductible, legal HSAs are being mixed with the excess HSAs in the math, which is incorrect; or that the chosen benchmark of comparing ending values is hiding a problem like the source of funds for the 6% excise tax while paying stock tax drag out of account balance; or that the basis of the stock account has not been increased owing to dividend reinvestment. If the calculations are performed correctly, the IRR on the aftertax value of the taxable stock should beat the IRR on the pretax balance of the HSA.
I think the bolded part is where I am going wrong. If I account for the forgone market gains on the excise tax, that eats into the excess HSA balance significantly, bringing it below the taxable account.
I agree you have a source-of-funds or opportunity cost problem for the excise tax amount each year. You also appear to be assuming that the excess HSA contributions are still tax deductible, so you're comparing the full excess contribution to a taxable brokerage account less income taxes paid. I do not believe this is correct. If you review Form 8889 and its instructions closely, I believe you will find that you are only allowed to take a deduction for the maximum annual contribution of $7300 or so.

https://www.irs.gov/pub/irs-pdf/f8889.pdf
https://www.irs.gov/instructions/i8889
I’m not deducting the excess. In my model column F shows the income tax that I am paying each year against the excess contribution.

So the final Ledger is:

$1.4M ending HSA balance - $104k income taxes paid over the years on the excess contributions - $249k Excise taxes paid over the years - some unknown amount of excise tax opportunity cost
petulant
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Re: Does it make sense to intentionally overfund HSA?

Post by petulant »

CletusCaddy wrote: Wed Aug 03, 2022 12:05 pm
petulant wrote: Wed Aug 03, 2022 11:58 am
CletusCaddy wrote: Wed Aug 03, 2022 11:42 am
petulant wrote: Wed Aug 03, 2022 11:01 am It is a sound idea that the excise tax of 6% can be beaten by compounding since the tax is only owed on the original contribution, not the whole account. But the tax drag of a 6% excise tax on original excess contributions will greatly exceed the tax drag on dividends from a stock index fund. For example, an initial investment of $100 might produce annual dividends of $1.60, which even at a tax rate of 30% would only be $.48, much less than $6. With compounding of the original $100, it takes until year 28 for the dividend tax drag to exceed $6. If OP's math is showing an excess HSA contribution beating a taxable account, something is wrong in the math. For example, it could be that the deductible, legal HSAs are being mixed with the excess HSAs in the math, which is incorrect; or that the chosen benchmark of comparing ending values is hiding a problem like the source of funds for the 6% excise tax while paying stock tax drag out of account balance; or that the basis of the stock account has not been increased owing to dividend reinvestment. If the calculations are performed correctly, the IRR on the aftertax value of the taxable stock should beat the IRR on the pretax balance of the HSA.
I think the bolded part is where I am going wrong. If I account for the forgone market gains on the excise tax, that eats into the excess HSA balance significantly, bringing it below the taxable account.
I agree you have a source-of-funds or opportunity cost problem for the excise tax amount each year. You also appear to be assuming that the excess HSA contributions are still tax deductible, so you're comparing the full excess contribution to a taxable brokerage account less income taxes paid. I do not believe this is correct. If you review Form 8889 and its instructions closely, I believe you will find that you are only allowed to take a deduction for the maximum annual contribution of $7300 or so.

https://www.irs.gov/pub/irs-pdf/f8889.pdf
https://www.irs.gov/instructions/i8889
I’m not deducting the excess. In my model column F shows the income tax that I am paying each year against the excess contribution.

So the final Ledger is:

$1.4M ending HSA balance - $104k income taxes paid over the years on the excess contributions - $249k Excise taxes paid over the years - some unknown amount of excise tax opportunity cost
But in the column for the taxable account, you are deducting the income taxes from the amount invested. That's the problem. Either the contribution to the taxable account matches the excess contribution to the HSA, or the income taxes paid on the HSA contribution need their own opportunity cost/IRR removal. Look at it like this. Say you're getting $7300 in the HSA as an excess contribution. We agree you paid taxes to put it there. Dollar-for-dollar, paying the same taxes, you should be able to get $7300 in a taxable brokerage account. Right?
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

My calculations show that the excess HSA balance after 30 years would be ~1.4M as you calculate, but you have to subtract out about $764k in excise taxes, including the opportunity cost to invest that money similarly. This results in a net $662,858 excluding any taxes to withdraw.

In contrast, investing the same money in a taxable account would grow to $1,328,553 before taxes to sell, assuming the same return, a 2% dividend included in the return and a 20% tax on that dividend annually.

All returns compounded annually.
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Re: Does it make sense to intentionally overfund HSA?

Post by Lee_WSP »

02nz wrote: Wed Aug 03, 2022 11:28 am
AnEngineer wrote: Wed Aug 03, 2022 11:20 am
CletusCaddy wrote: Wed Aug 03, 2022 11:15 am
AnEngineer wrote: Wed Aug 03, 2022 9:48 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Can someone confirm my math?
Can you clarify how you're using your numbers? I'm not finding the same values.
Here is the spreadsheet:
https://docs.google.com/spreadsheets/d/ ... sp=sharing

I'm not convinced this is correct. The biggest question I have is whether on the Excess HSA side I should be accounting for the opportunity cost of lost gains on the excise tax being paid every year. Right now the model ignores this.
The biggest error I see is that your taxable comparison point assumes that you have to pay more taxes. You don't get to deduct excess HSA contributions on your income. You pay the same income taxes up front in both cases.
So the "overfunded" HSA is basically a nondeductible tIRA with a fee of 6% of original contributions every year, unless it can actually be used for medical expenses? That doesn't seem likely to work out very well.
Assuming the withdrawals are not taxed, it sounds more like a Roth with a 6% fee.
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CletusCaddy
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Re: Does it make sense to intentionally overfund HSA?

Post by CletusCaddy »

AnEngineer wrote: Wed Aug 03, 2022 12:55 pm My calculations show that the excess HSA balance after 30 years would be ~1.4M as you calculate, but you have to subtract out about $764k in excise taxes, including the opportunity cost to invest that money similarly. This results in a net $662,858 excluding any taxes to withdraw.

In contrast, investing the same money in a taxable account would grow to $1,328,553 before taxes to sell, assuming the same return, a 2% dividend included in the return and a 20% tax on that dividend annually.

All returns compounded annually.
Thank you, I think this closes the case.
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Re: Does it make sense to intentionally overfund HSA?

Post by retiringwhen »

CletusCaddy wrote: Wed Aug 03, 2022 11:15 am
AnEngineer wrote: Wed Aug 03, 2022 9:48 am
CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Can someone confirm my math?
Can you clarify how you're using your numbers? I'm not finding the same values.
Here is the spreadsheet:
https://docs.google.com/spreadsheets/d/ ... sp=sharing

I'm not convinced this is correct. The biggest question I have is whether on the Excess HSA side I should be accounting for the opportunity cost of lost gains on the excise tax being paid every year. Right now the model ignores this.
#1 - You are not comparing apples to apples in the after-tax brokerage account. the contributions to taxable should include the excise tax that is avoided. So:

HSA Contribution + Excise Tax - income taxes avoided = annual contribution to after tax brokerage. I updated column h computation to be b+d-e. This makes the the taxable account a better deal directly. Results are: $1.69M in taxable brokerage account.

#2 Future returns will be variable, but the excise tax is fixed regardless of return. Sequence of Returns risk could seriously destroy any potential advantage. The tax law is aware of this risk and figures the penalty is sufficient to dissuade such an action. This should be reason enough to avoid the strategy.

#3 10% nominal is a pretty high bar to expect going forward where the entire plan is dependent on an excess rate of return.

#4 the Taxable brokerage account is likely taxed at 20% LTCG on only the growth of the fund vs. the 35% on the total balance for the HSA. you also should consider the drag of dividend taxes on the brokerage balance (I assume 20% QDI on 2% dividends). In my take on this, the brokerage net is $1.35M and the HSA is $927K. The liquidation tax drag is huge.

Bottom line, this is a good way to pay uncle sam a lot more taxes and end up with less money.
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Re: Does it make sense to intentionally overfund HSA?

Post by retiringwhen »

I see AnEngineer beat me to the major point!
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

retiringwhen wrote: Wed Aug 03, 2022 1:42 pm #1 - You are not comparing apples to apples in the after-tax brokerage account. the contributions to taxable should include the excise tax that is avoided. So:

HSA Contribution + Excise Tax - income taxes avoided = annual contribution to after tax brokerage. I updated column h computation to be b+d-e. This makes the the taxable account a better deal directly. Results are: $1.69M in taxable brokerage account.
I think we've converged, but I just want to reiterate that excess HSA contributions do not avoid any income taxes.
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Re: Does it make sense to intentionally overfund HSA?

Post by retiringwhen »

AnEngineer wrote: Wed Aug 03, 2022 1:49 pm
retiringwhen wrote: Wed Aug 03, 2022 1:42 pm #1 - You are not comparing apples to apples in the after-tax brokerage account. the contributions to taxable should include the excise tax that is avoided. So:

HSA Contribution + Excise Tax - income taxes avoided = annual contribution to after tax brokerage. I updated column h computation to be b+d-e. This makes the the taxable account a better deal directly. Results are: $1.69M in taxable brokerage account.
I think we've converged, but I just want to reiterate that excess HSA contributions do not avoid any income taxes.
Right, you can't deduct the excess contribution, thus the results are even more skewed to the brokerage account (my calculations show a post liquidation value of $1.7M almost twice the HSA).

I did the calculation differently by assuming the excise tax is invested in the taxable brokerage account. Just a different treatment of that cost.

There is a lesson here. The tax deferral benefits of a low-cost index ETF in a brokerage account is pretty good stuff that is hard to beat! Good to work a corner case.
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Re: Does it make sense to intentionally overfund HSA?

Post by Lee_WSP »

AnEngineer wrote: Wed Aug 03, 2022 1:49 pm
retiringwhen wrote: Wed Aug 03, 2022 1:42 pm #1 - You are not comparing apples to apples in the after-tax brokerage account. the contributions to taxable should include the excise tax that is avoided. So:

HSA Contribution + Excise Tax - income taxes avoided = annual contribution to after tax brokerage. I updated column h computation to be b+d-e. This makes the the taxable account a better deal directly. Results are: $1.69M in taxable brokerage account.
I think we've converged, but I just want to reiterate that excess HSA contributions do not avoid any income taxes.
I haven’t double checked it as the whole idea is looney to begin with, but the excess and growth on the excess is taxed as ordinary income? So you have to do a pro rata calculation like a non deducted Ira? Can you point to the statute or rule?
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

Lee_WSP wrote: Wed Aug 03, 2022 3:27 pm
AnEngineer wrote: Wed Aug 03, 2022 1:49 pm
retiringwhen wrote: Wed Aug 03, 2022 1:42 pm #1 - You are not comparing apples to apples in the after-tax brokerage account. the contributions to taxable should include the excise tax that is avoided. So:

HSA Contribution + Excise Tax - income taxes avoided = annual contribution to after tax brokerage. I updated column h computation to be b+d-e. This makes the the taxable account a better deal directly. Results are: $1.69M in taxable brokerage account.
I think we've converged, but I just want to reiterate that excess HSA contributions do not avoid any income taxes.
I haven’t double checked it as the whole idea is looney to begin with, but the excess and growth on the excess is taxed as ordinary income? So you have to do a pro rata calculation like a non deducted Ira? Can you point to the statute or rule?
I'm not sure if you pay the excise tax if you can avoid treating it as ordinary income if you have medical expenses. However, if you withdraw to avoid the penalty, then the gains are taxed as ordinary income. From 8889 instructions (linked above):
Excess Contributions You Make
To figure your excess contributions (including those made on your behalf), subtract your deductible contributions (line 13) from your actual contributions (line 2). However, you can withdraw some or all of your excess contributions for 2021 and they will be treated as if they had not been contributed if:

You make the withdrawal by the due date, including extensions, of your 2021 tax return (but see the Note under Excess Employer Contributions, later);
You do not claim a deduction for the amount of the withdrawn contributions; and
You also withdraw any income earned on the withdrawn contributions and include the earnings in “Other income” on your tax return for the year you withdraw the contributions and earnings.
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Re: Does it make sense to intentionally overfund HSA?

Post by Lee_WSP »

It would make sense that the excess is the first out and keeping it in will compound the pain via no cap gains treatment. Again, the whole idea is so looney, I’ve never bothered to look it up.
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

Lee_WSP wrote: Wed Aug 03, 2022 3:44 pm It would make sense that the excess is the first out and keeping it in will compound the pain via no cap gains treatment. Again, the whole idea is so looney, I’ve never bothered to look it up.
It may not even be that well figured out in law. I haven't found any rules for computing the associated earnings for HSAs, but I've seen an HSA form point at the IRA rules.
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Re: Does it make sense to intentionally overfund HSA?

Post by Lee_WSP »

AnEngineer wrote: Wed Aug 03, 2022 3:47 pm
Lee_WSP wrote: Wed Aug 03, 2022 3:44 pm It would make sense that the excess is the first out and keeping it in will compound the pain via no cap gains treatment. Again, the whole idea is so looney, I’ve never bothered to look it up.
It may not even be that well figured out in law. I haven't found any rules for computing the associated earnings for HSAs, but I've seen an HSA form point at the IRA rules.
It was written to basically be a savings account and then they added the investment feature to it so I would not be surprised if there are no regulations on the order of withdrawals. But absent any regs, I'd assume the worst. Worst out first.
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Re: Does it make sense to intentionally overfund HSA?

Post by toddthebod »

Lee_WSP wrote: Wed Aug 03, 2022 3:27 pm
AnEngineer wrote: Wed Aug 03, 2022 1:49 pm
retiringwhen wrote: Wed Aug 03, 2022 1:42 pm #1 - You are not comparing apples to apples in the after-tax brokerage account. the contributions to taxable should include the excise tax that is avoided. So:

HSA Contribution + Excise Tax - income taxes avoided = annual contribution to after tax brokerage. I updated column h computation to be b+d-e. This makes the the taxable account a better deal directly. Results are: $1.69M in taxable brokerage account.
I think we've converged, but I just want to reiterate that excess HSA contributions do not avoid any income taxes.
I haven’t double checked it as the whole idea is looney to begin with, but the excess and growth on the excess is taxed as ordinary income? So you have to do a pro rata calculation like a non deducted Ira? Can you point to the statute or rule?
Is this what you are looking for?

26 USC §223 (f)(3)(A)
‘(A) IN GENERAL.—If any excess contribution is contributed for a taxable year to any health savings account
of an individual, paragraph (2) shall not apply to distributions from the health savings accounts of such individual
(to the extent such distributions do not exceed the aggregate excess contributions to all such accounts of such individual for such year) if—
(i) such distribution is received by the individual
on or before the last day prescribed by law (including
extensions of time) for filing such individual’s return
for such taxable year, and
(ii) such distribution is accompanied by the
amount of net income attributable to such excess contribution.
Any net income described in clause (ii) shall be included
in the gross income of the individual for the taxable year
in which it is received.
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Re: Does it make sense to intentionally overfund HSA?

Post by Lee_WSP »

toddthebod wrote: Wed Aug 03, 2022 4:55 pm
Lee_WSP wrote: Wed Aug 03, 2022 3:27 pm
AnEngineer wrote: Wed Aug 03, 2022 1:49 pm
retiringwhen wrote: Wed Aug 03, 2022 1:42 pm #1 - You are not comparing apples to apples in the after-tax brokerage account. the contributions to taxable should include the excise tax that is avoided. So:

HSA Contribution + Excise Tax - income taxes avoided = annual contribution to after tax brokerage. I updated column h computation to be b+d-e. This makes the the taxable account a better deal directly. Results are: $1.69M in taxable brokerage account.
I think we've converged, but I just want to reiterate that excess HSA contributions do not avoid any income taxes.
I haven’t double checked it as the whole idea is looney to begin with, but the excess and growth on the excess is taxed as ordinary income? So you have to do a pro rata calculation like a non deducted Ira? Can you point to the statute or rule?
Is this what you are looking for?

26 USC §223 (f)(3)(A)
‘(A) IN GENERAL.—If any excess contribution is contributed for a taxable year to any health savings account
of an individual, paragraph (2) shall not apply to distributions from the health savings accounts of such individual
(to the extent such distributions do not exceed the aggregate excess contributions to all such accounts of such individual for such year) if—
(i) such distribution is received by the individual
on or before the last day prescribed by law (including
extensions of time) for filing such individual’s return
for such taxable year, and
(ii) such distribution is accompanied by the
amount of net income attributable to such excess contribution.
Any net income described in clause (ii) shall be included
in the gross income of the individual for the taxable year
in which it is received.
No, because it only deals with excess contributions returned during that calendar year. If you read the rest of the statute, it doesn't state there's a priority of withdrawals. There's simply an excise tax on the excess and it says no income tax on qualified medical expenses. So, based solely on the statute, so long as the excess is used for qualifying medical expenses, the statute says no income tax shall be assessed. Usually the regs clear things like this up saying that the priority of withdrawals shall be: 1) withdraw any excess contributions, 2) used for qualifying medical expenses.

It's probably going to be treated similar to excess IRA contributions. In fact, there has to be people out there with excess contributions who never took it out, so this is not some hypothetical problem, just one I haven't had to deal with as this is not the type of problem I deal with.
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Re: Does it make sense to intentionally overfund HSA?

Post by AnEngineer »

Lee_WSP wrote: Wed Aug 03, 2022 5:00 pm
toddthebod wrote: Wed Aug 03, 2022 4:55 pm
Lee_WSP wrote: Wed Aug 03, 2022 3:27 pm
AnEngineer wrote: Wed Aug 03, 2022 1:49 pm
retiringwhen wrote: Wed Aug 03, 2022 1:42 pm #1 - You are not comparing apples to apples in the after-tax brokerage account. the contributions to taxable should include the excise tax that is avoided. So:

HSA Contribution + Excise Tax - income taxes avoided = annual contribution to after tax brokerage. I updated column h computation to be b+d-e. This makes the the taxable account a better deal directly. Results are: $1.69M in taxable brokerage account.
I think we've converged, but I just want to reiterate that excess HSA contributions do not avoid any income taxes.
I haven’t double checked it as the whole idea is looney to begin with, but the excess and growth on the excess is taxed as ordinary income? So you have to do a pro rata calculation like a non deducted Ira? Can you point to the statute or rule?
Is this what you are looking for?

26 USC §223 (f)(3)(A)
‘(A) IN GENERAL.—If any excess contribution is contributed for a taxable year to any health savings account
of an individual, paragraph (2) shall not apply to distributions from the health savings accounts of such individual
(to the extent such distributions do not exceed the aggregate excess contributions to all such accounts of such individual for such year) if—
(i) such distribution is received by the individual
on or before the last day prescribed by law (including
extensions of time) for filing such individual’s return
for such taxable year, and
(ii) such distribution is accompanied by the
amount of net income attributable to such excess contribution.
Any net income described in clause (ii) shall be included
in the gross income of the individual for the taxable year
in which it is received.
No, because it only deals with excess contributions returned during that calendar year. If you read the rest of the statute, it doesn't state there's a priority of withdrawals. There's simply an excise tax on the excess and it says no income tax on qualified medical expenses. So, based solely on the statute, so long as the excess is used for qualifying medical expenses, the statute says no income tax shall be assessed. Usually the regs clear things like this up saying that the priority of withdrawals shall be: 1) withdraw any excess contributions, 2) used for qualifying medical expenses.

It's probably going to be treated similar to excess IRA contributions. In fact, there has to be people out there with excess contributions who never took it out, so this is not some hypothetical problem, just one I haven't had to deal with as this is not the type of problem I deal with.
More fundamental than withdrawal order, is there even provision that withdrawals of excess contributions or associated earnings are treated any differently when done later?
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Re: Does it make sense to intentionally overfund HSA?

Post by Lee_WSP »

AnEngineer wrote: Wed Aug 03, 2022 5:19 pm
Lee_WSP wrote: Wed Aug 03, 2022 5:00 pm
toddthebod wrote: Wed Aug 03, 2022 4:55 pm
Lee_WSP wrote: Wed Aug 03, 2022 3:27 pm
AnEngineer wrote: Wed Aug 03, 2022 1:49 pm
I think we've converged, but I just want to reiterate that excess HSA contributions do not avoid any income taxes.
I haven’t double checked it as the whole idea is looney to begin with, but the excess and growth on the excess is taxed as ordinary income? So you have to do a pro rata calculation like a non deducted Ira? Can you point to the statute or rule?
Is this what you are looking for?

26 USC §223 (f)(3)(A)
‘(A) IN GENERAL.—If any excess contribution is contributed for a taxable year to any health savings account
of an individual, paragraph (2) shall not apply to distributions from the health savings accounts of such individual
(to the extent such distributions do not exceed the aggregate excess contributions to all such accounts of such individual for such year) if—
(i) such distribution is received by the individual
on or before the last day prescribed by law (including
extensions of time) for filing such individual’s return
for such taxable year, and
(ii) such distribution is accompanied by the
amount of net income attributable to such excess contribution.
Any net income described in clause (ii) shall be included
in the gross income of the individual for the taxable year
in which it is received.
No, because it only deals with excess contributions returned during that calendar year. If you read the rest of the statute, it doesn't state there's a priority of withdrawals. There's simply an excise tax on the excess and it says no income tax on qualified medical expenses. So, based solely on the statute, so long as the excess is used for qualifying medical expenses, the statute says no income tax shall be assessed. Usually the regs clear things like this up saying that the priority of withdrawals shall be: 1) withdraw any excess contributions, 2) used for qualifying medical expenses.

It's probably going to be treated similar to excess IRA contributions. In fact, there has to be people out there with excess contributions who never took it out, so this is not some hypothetical problem, just one I haven't had to deal with as this is not the type of problem I deal with.
More fundamental than withdrawal order, is there even provision that withdrawals of excess contributions or associated earnings are treated any differently when done later?
That also wasn’t in the statute from what I read. There was a provision regarding when the account is no longer an HSA so disqualification would be a pretty severe penalty.

Actually, that may well be the penalty for over contributing or over contributing in such a manner as OP is proposing is simply not practical. Per the statute, the trustee's governing instrument cannot allow you to over contribute.

See section (d) of the statute:
(d)Health savings account
For purposes of this section—
(1)In general
The term “health savings account” means a trust created or organized in the United States as a health savings account exclusively for the purpose of paying the qualified medical expenses of the account beneficiary, but only if the written governing instrument creating the trust meets the following requirements:
(A)Except in the case of a rollover contribution described in subsection (f)(5) or section 220(f)(5), no contribution will be accepted—
(i)unless it is in cash, or
(ii)to the extent such contribution, when added to previous contributions to the trust for the calendar year, exceeds the sum of—
(I)the dollar amount in effect under subsection (b)(2)(B), and
(II)the dollar amount in effect under subsection (b)(3)(B).
Last edited by Lee_WSP on Wed Aug 03, 2022 9:18 pm, edited 1 time in total.
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Re: Does it make sense to intentionally overfund HSA?

Post by whodidntante »

Approved.
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Re: Does it make sense to intentionally overfund HSA?

Post by Oregano »

CletusCaddy wrote: Wed Aug 03, 2022 12:46 am Let’s assume the following:

1. You intentionally fund two HSAs to the maximum every year for 30 years. Let’s assume both spouses have access to HSAs.
2. HSA limits increase by 2% every year.
3. You are in 35% tax bracket every year.
4. Excise tax on cumulative excess contribution is 6% every year.
5. 10% CAGR on invested money

Keep all figures nominal.

Under this scenario my spreadsheet tells me that by the end of year 30, my excess HSA account will reach an ending amount of $1.43M. Over the 30 years I will have paid cumulative income taxes of $104k and penalties of $249k. Net net, I end up with $1.07M post tax post penalty. At this point I withdraw all of the cumulative excess contributions to stop the penalty.

If I had invested that excess HSA money (post tax) into taxable instead, I would have ended up with $0.93M, most of which is capital gains.

Can someone confirm my math? Is this a hidden tax opportunity under all of our noses?
Just put the money in a taxable account and earn the 10% (your assumption, not mine). The annual taxes on the taxable account will be WAY less than 6%, so the taxable account will come out ahead.

Whatever math you did is definitely wrong. Did you assume you could take a tax deduction on the excess contributions or something? That won't be allowed.
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