Post-FIRE: What about the HSA?

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The Health Savings Account is commonly referred to as the Ultimate Retirement Account thanks to the MadFientist’s article from 2012.   I’ve been fortunate enough to have access to an HSA since 2007 and we avoided major medical expenses until 2015, allowing funds to slowly build up.

Even after retiring early, we have contributed to our HSA.  We get a federal and state tax deduction for putting money in and, unlike the Roth IRA, it doesn’t come with an earned income requirement.   In late 2019, I was able to move our HSA from my previous employer to Fidelity, further lowering the costs I previously complained about.

To Save or Not Save Receipts

I’ve mostly saved receipts, paying medical expenses out of pocket and letting investment gains in the HSA grow.   I distributed one round of receipts in 2018 and recently distributed the remaining saved receipts in July of 2021.  Now we’re doing a combination of paying smaller expenses directly from the HSA while still putting larger expenses on a rewards card for incremental reimbursements a few times a year.  We like the points and can always decide to reimburse when we’re ready.

Why Are We Mostly Using the HSA Now?

Pre-Tax vs Post-Tax Balance:  More than 55% of our assets are in pre-tax accounts.  Thanks to all of the gains after I retired, I don’t know if we can ever navigate all the money out at attractive tax rates.   This falls in the category of a “good” problem, but an issue to consider in the future.  Withdrawing these funds today boosted our taxable accounts and the future investment earnings will be outside of retirement accounts.  

Can you save too much in HSA?  Our HSA briefly touched six figures, yet we have health insurance with a maximum out of pocket or $6,750 per person.  In a bad year, maybe we spend 8-9% of the balance of the HSA.  That’s still less than the average return of the S&P 500 and we still contributed the $7,200 in January of 2021.   I may hold off on future contributions until the end of the year in future periods, utilizing the tool if needed to avoid that 12% to 22% jump in federal tax rates.  

The COBRA surprise:  I utilized COBRA for health insurance in the final seven months of 2019.  At the time I didn’t realize that COBRA premiums are the one type of health insurance that is HSA eligible!   This created around $8,000 in additional eligible dollars I was unaware of before.

The Inheritance Challenge:   The HSA does not have the 10 year distribution rules of IRAs or the step up basis of regular accounts.  When the owner and spouse of an HSA pass, income taxes are due in full by the beneficiary.  If your beneficiary is currently employed, that entire balance could be taxed anywhere from 22% to 40%+ depending on their federal and state income tax situation.  Hopefully this is five decades away for me, but today’s rules make the HSA the least friendly account for estate planning. 

Tax Optimization is no longer a top priority:  I don’t enjoy paying taxes, but the game has changed for me now that I’ve given up the W2 job.  We will happily realize $105,000 or so in income a year to fill up the 12% federal tax bracket plus we pay another 7% to our state.  Dividends and interest are tax free below those thresholds.  The money was put away pre-tax, deferred the tax liability, and now we pay that deferred liability at a slightly lower rate.  We already won the game and any optimization past keeping our income in the 12% bracket seems like a moot point.

Flexibility:  After tax dollars are far more useful to us now.  We eventually want a house and I look like an unemployed bum to a mortgage company.  After-tax dollars/investments are easier for private placement investments, can be borrowed against, and can be used at any time for expenses.  We value putting flexibility over additional pre tax dollars.

Wrapping Up

The HSA was a nice tool for tax optimization on our path to early retirement.  It acted as an additional savings account and a way to stash some dollars for future use.  Now that we’ve successfully FIREd from full time employment, the goals and purpose of this account have changed.  

Notes:  Thank Mrs. PIE (Plan, Invest, Escape) for the twitter discussion encouraging this article. 

4 Replies to “Post-FIRE: What about the HSA?”

  1. How about fees? I have been maxing out my HSA (single) for last 2 years and saving receipts. I’ve invested the max allowed amount, but am unsure of the fee structure for the invested amount compared to my vanguard ETF.

    You say you touched six figures. I still wonder what is this right amount (% of expected living expense) in accounts you can’t touch til retirement age (59.5) and accounts you can touch pre retirement age. Do you consider the HSA the latter, based on the receipts you have?

    1. The fees are a good question, you should be able to look up the individual mutual funds for those fees with a site like Morningstar, then it’s a bit more difficult to figure out administrative fees because it’s something I was only mailed once a year.

      As for the account types, the two things that are completely inaccessibility without penalty are earnings inside a Roth IRA and HSA contributions without offsetting expenses. The HSA carries a 20% penalty too.

      The pretax savings like the 401k don’t seem as bad so far, I’ve been able to convert some to a Roth IRA, use a special one time distribution allowed in 2020, and could setup a 72t in the future and get about 2.3% of the balance out a year between now and 59.5. The more I study is, the 72t is an outstanding tool for people to start between 50-55.

  2. Wow, did *not* know HSA can pay for COBRA. This is actually huge and makes me glad I’ve been maxing out each year in my HSA.

    When I do finally FIRE, seems like that’ll keep me afloat for quite a while without having to go “out of pocket” in the post-tax sense.

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