Strategizing HSA versus itemized medical expenses

[joelrlevy]

Here is the scenario.  We have always maxed out our HSA contributions (now, including catch-up) and will continue to do so until Medicare.  We rarely have actually used the HSA card, etc. to pay for medical expenses, instead paying by credit card (points, baby!) and then using the HSA to reimburse ourselves (we keep very detailed accounting of it).  

I know these facts:

• HSA distributions can pay for expenses in previous years, not just the year of the distribution (yes, expenses incurred after HSA created).  
• It is the contribution that is deductible each year.
• Reimbursements are not taxed, as long as they are used for medical expenses, no matter when the expense was incurred.
• In some years we used standard deduction, other years we itemized.  If we claimed itemized medical expenses in those years, it was net of any HSA reimbursements and the 7.5% limit.  We never "double dipped" those expenses.

In 2024, we made the full HSA contribution and had distributions that covered some previous year expenses as well as some 2024.  It happened to be a fairly high medical expense year and would potentially push us into itemizing.  That having been said, 2025, and for the next few years (knock on wood), we anticipate lower medical expenses as our child will no longer be covered under our plan/expenses.  

So here is the question: Do we itemize the additional medical expenses from 2024 or do we take the standard deduction and just use future HSA  disbursements to cover them?  We do not anticipate having expenses in 2025 that exceed the contribution maximum.  I know we can leave funds in the HSA to earn tax free for future expenses, but frankly there are better tax-advantaged options.

Thanks in advance!

[BillM223 · Accepted solution]

I congratulate you on your understanding of HSAs.

1. After you turn 65, the HSA becomes like a funny IRA. While you can still reimburse yourself tax-free for medical expenses, you can also take distributions with no penalty after age 65 (you pay regular income tax, of course, just like with an IRA). 

2. There is no RMD requirement with an HSA, unlike with an IRA.

3. Some HSA custodians permit you to invest in a variety of investment vehicles: stocks, mutual funds, whatever the custodian allows. So maybe it is time to look at another HSA custodian.

4. It is hard to imagine a situation in which using Schedule A beats an HSA. If your marginal tax rate is 24%, then each dollar of expense IN EXCESS OF 7.5% of your AGI is worth 24 cents. But spending the same money from the HSA is tax-free.

Why don't you take the distribution from your HSA and take the Standard Deduction? It's sort of double-dipping - the Standard Deduction covers a "standard" amount of medical expenses, and the same expenses are reimbursed by the HSA.

[joelrlevy]

@BillM223 That was very much my thinking as well.  The biggest difference between 2024/2025 and previous years is that in the past we always had medical expenses in excess of the max contribution (or at least some catch-up reimbursements). 

Good idea to switch custodians too as I will "medicare-ing out" of HSA contributions in about 3 years (its currently my HSA), but my wife has 7 more years.

Thanks!

[dmertz]

The down side of using the HSA to pay the expenses is that that money is no longer in the HSA to continue to grow tax free (as long as it is eventually used to pay for qualified medical expenses).  Knowing which way to pay for the medical expenses now depends a lot on predicting the future.

[joelrlevy]

@dmertz  Thanks for the reply.  Where to pay expenses from has many factors, not just predicting the future.  What are the investment opportunities offered by the custodian?  Where would the money be drawn from instead and at what real and opportunity costs?  I am retired.  If I pull money from my IRA to contribute to the HSA, the distribution income is offset by the contribution.  If I need to pull an additional amount to pay the expenses, that is not offset.  I'd rather use the HSA funds and take that additional distribution (taxable) and convert to a Roth where I probably have more investment options, grows tax free, and can be withdrawn for any reason, not just medical, tax free.