Is It Better to Save or Spend My HSA?
Mathematically, it is optimal to pay for qualified medical expenses out of pocket and seek reimbursement from your HSA after contributions have had time to grow. To do this, you will need to develop a system for keeping solid records and tracking expenses.
Health Savings Accounts (HSAs) provide a unique tax-advantaged opportunity by allowing account owners to pay for qualified medical expenses, completely tax-free.
Additionally, HSA owners have the option to invest their account funds just like a regular retirement account, such as an IRA or 401(k).
Once account holders turn 65, they can begin withdrawing from their HSA penalty-free for any reason, though they will owe income tax on any distributions that aren’t used for medical expenses.
This hybrid characteristic makes HSAs uniquely flexible as both a medical savings and retirement savings vehicle.
It also leaves those of us who have HSAs with a decision to make.
Should we spend the money in our HSAs when we realize a qualified medical expense, or would we be better off leaving the money in the account to grow as an investment?
Before you jump to any conclusions, remember that medical expenses can be reimbursed from an HSA at any time. There is no limitation.
So, you could potentially pay for immediate medical expenses out of pocket, only to seek reimbursement from the HSA months or years down the road after your contributions have had extensive time to grow.
In this way, you can reap the best of both worlds, earnings from compounding interest and completely tax-free medical expenses.
Let’s walk through the options to gain a better understanding of what’s at stake.
As we do so, we’re going to assume that the account owner in each case is actively investing through their HSA.
If you aren’t investing your HSA, then this is a bit of a moot point because there’s no opportunity cost for spending the money in the account as soon as you incur an expense. Spending the money is the only way to receive any benefit from the account when it’s used this way.
Option 1: Spend the HSA Money As Medical Expenses Are Incurred
In option 1 medical costs are paid directly from the HSA as soon as they are incurred.
The obvious benefit to this choice is that you’re done with the transaction once you’ve paid for it and saved the receipt for your records.
There’s no need to keep careful records to ensure you harvest your benefits later and you’re only holding onto receipts in case you’re audited for some reason.
The downside is that once HSA dollars are removed from the account, they can’t be replaced. Your annual contribution limit ($4,150 single, $8,300 MFJ in 2024) is a one-way calculation. You don’t get to debit and replace expenses you incur.
So, once the money is out of the account you will never be able to invest those dollars in an HSA again.
That’s the opportunity cost associated with spending out of your HSA.
But paying for medical expenses out-of-pocket doesn’t mean you’re spending every dollar in the account either.
If you’re saving the annual maximum, you’ll probably only spend a portion of the available balance in any given year. This is especially true if you’ve saved beyond the annual maximum out-of-pocket cost limit for your insurance plan.
Therefore, the lost opportunity cost is at least limited to the amount you spend and not more.
With all of that said, there’s still an opportunity cost for using the money, meaning there is an opportunity to use the HSA in a more financially efficient manner.
Which brings us to…
Option 2: Pay For Medical Expenses Outside of Your HSA; Seek Reimbursement Later
In option 2, the goal is to leave the HSA dollars in the account for as long as possible, so the earning potential of your contributions is maximized.
Eventually, you can seek reimbursement for previously incurred medical expenses so your tax-free benefits are preserved.
Mathematically, this is the most optimal way to operate your HSA because you get the best of both tax-advantaged investing and tax-free medical expenses.
For example, every $100 you don’t spend from the HSA would be worth $672.75 in 20 years with a 10% rate of return. That means your opportunity cost over those 20 years is $572.75.
Seems like a lot when you look at it that way.
The major downside to this method is the need to keep careful records of your medical expenses for as long as you delay the reimbursement (and technically longer since you should hold them in case of an audit).
For some people, this is not a big deal.
For others, it may seem like a massive and unnecessary headache.
Another item to consider is the risk of losing your medical expense records.
I can’t speak for everyone here, but I have doubts about my ability to save anything for very long.
Hanging onto receipts (even electronically) for years at a time seems like a surefire way for me to lose them, and my potential tax savings, for good.
You should take this risk into account or at least be sure you mitigate it in the event you decide to save your receipts and records for reimbursement.
Option 3: A Little Bit of Both
In this option, you basically take things on a case-by-case basis.
Potentially, you could save receipts and records to be reimbursed for large medical expenses and preserve the ability of those dollars to earn interest through investments, while also paying for minor costs from the HSA so you don’t have to bother with recording a large volume of small costs.
Or, you could pay for the large expenses from the HSA and seek reimbursement later for the small ones.
There’s total flexibility here. Primarily, I just want to highlight the fact that you don’t have to do all of one or the other.
For example, just this week I purchased a generic antibiotic for one of my kids. With prescription insurance it cost me a whopping $3.94.
In this case, I handed the pharmacist my HSA debit card and paid for it from the account because I don’t see much value in leaving such a paltry sum in my HSA to grow while also having to keep up with the receipt for it.
The interest on $3.94 isn’t worth the hassle factor.
On the other hand, I had an MRI back in January that was north of $1,000. I’ll admit, the tax-free interest on $1,000 wouldn’t be anything to sneeze at.
Sparing your HSA from a big expense like the MRI might make sense depending on your own cash situation.
Conclusion
In summary, if your priority is to optimize the tax and investing benefits of an HSA, then you should pay for medical expenses out of pocket and seek reimbursement down the road.
If the thought of maintaining detailed (and I do mean detailed) records about your medical expenses sounds terrible to you, then maybe you should just pay them out of the account as they come up.
This really is more of a personal preference than a mathematical decision, but now you know the costs.
Either way, if you’re using the HSA you’re definitely making or more financially efficient choice than forgoing the option altogether.
