I see your logic here. Non-medical withdrawals from an HSA are taxed in the same way as a deductible IRA, versus the proration of withdrawals from a non-deductible IRA. But if you know that any further growth in your HSA will eventually become taxable, then leaving $X in your HSA, rather than $X in your taxable account, is analogous to investing $X in a non-deductible IRA: all gains in the HSA are taxed as ordinary income upon your death.I used to think this way, but I no longer think that's completely correct. The key is to separate the decision of contributing to an HSA in the first place, with how best to use it once you have it.The correct comparison is to a deductible IRA. If you are in the 22% tax bracket and make non-medical withdrawals from the HSA, you pay 22% tax on the entire withdrawal, not just the gain, but this is offset by the deduction you got when you made the contribution.However, if the HSA balance exceeds medical expenses, then some of the HSA money will come out fully taxed as ordinary income, either by you or your heirs. It looks to me like a HSA in this situation behaves much like a non-deductible IRA.
For contribution, an HSA is better than a retirement account with no match, because you get an initial tax deduction, and the worst case is it behaves like a tIRA (or better, with the payroll tax deduction), but the best case is that it's tax-free on both ends. I think everyone agrees with this. But it's key that once you make the contribution, the initial deduction is "sunk benefit", and decisions afterward on how to use it should be made with regard to the benefit going forward. Once you have the account, the choice of whether to leave money in or take it out as medical expenses accrue is a choice of where you would prefer to have the money growing. It's also key to realize that there are two possibilities - either medical expenses will exceed the account balance such that all withdrawals will be tax-free, or they won't in which case some future withdrawals must be taxable. In the former case, you are getting true tax-free growth, like a Roth account, and I agree with prevailing wisdom that it's best to leave money in the HSA as long as possible (but taking those tax-free withdrawals before you die and leave it to a non-spouse, so that right doesn't get lost). It's on the second case - where the HSA balance will exceed available medical expenses - that I've revised my thinking.
And a non-deductible IRA is always better than a taxable account for bond investments, but may be worse for stock investments because of the preferential tax treatment of stock gains and the possibility of a stepped-up basis for your heirs.
Statistics: Posted by grabiner — Sat Jun 22, 2024 10:59 pm — Replies 5 — Views 542