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As a recent retiree who is using my cash reserves to cross my two-year “bridge” to my SS claiming date, I need to decide from which of my tax-free accounts I should withdraw to supplement our living expenses as I move into 2025. I will have used up my taxable account funds by the end of 2024.
Given our household’s low taxable income during this period I have been doing strategic (fill up the tax bracket, but keep my spouse eligible for a low ACA) Roth conversions that entail converting equity holdings from my Rollover IRA into my Roth IRA. This leaves an increasing proportion of my Rollover IRA in slower growing bond funds, thus reducing the level of future RMDs that I will be forced to take in the future.
I have built up significant cash reserves in my Roth IRA. I also have a low five-figure in balance in my HSA– all in a short-term government bond fund. These HSA funds have been invested while I used my taxable funds to pay my medical expenses, thus accumulating a stack HSA-eligible receipts, including an increasing proportion of Medicare-related premium receipts.
I need to make a choice…. do I use my Roth IRA cash reserves (invested in Vanguard’s Fed. MMF), or do I begin selling my short-term government bond funds in my Fidelity HSA account to begin funding my expenses in 2025? I realize my MMF interest rate is sensitive to the Fed’s. interest rate decisions and its NAV is directly correlated to that. Likewise, with my HSA short-term govt. bond investments— but their point-in-time value is also tied to the what the market will pay at the time I sell shares of that fund.
I realize the negative tax implications of not spending down my HSA and having it pass to a beneficiary, as compared to my Roth IRA balance being passed to a beneficiary with no negative tax implications as long as withdrawal rules are followed (spouse vs children).
I have the luxury of even facing this decision, but welcome the HD community’s counsel as I move forward. Is there a clear answer? Am I missing others things that I need to take in to account?
Thanks,
Bill
When my wife passed, I began reimbursement withdrawals from my HSA, using the accumulated medical receipts since 2004 and my Medicare part D premiums. My rationale here is the funds will become taxable income the moment they pass to my heirs, since they are not my spouse. the tax benefit is mine to use or lose, so…
Good question! We decided that spending our HSA’s and not touching our Roth IRA’s made the most sense. For us, it all boiled down to wanting to simplify our financial lives in preparation for our later years and wanting to let our Roth IRA’s continue growing for our heirs.
My wife and I each had our own HSA so there were two accounts to manage. My wife is technically challenged so I managed both accounts. If I were to pass away before my wife she would struggle with maintaining these accounts. Determining what qualifies for reimbursement and scanning and submitting receipts would be puzzling and frustrating for her. And managing these accounts could become more difficult for me in my later years if I begin to lose my mental abilities. So depleting the HSA’s just made good sense to us.
I hope this helps you out.
Lou,
I too am on the quest to simplify our finances, so depleting the HSA account would certainly serve that purpose. I am also the detail person in our family, so I keep and tally the receipts on an annual basis. I think I might just convert most of my accumulated HSA expenses at one time. Any excess that I don’t need I will use to contribute to my Roth IRA since I am currently earning some income from consulting. I would be sure not to have so much excess that it exceeds my earned income (or the $8k annual limit). In effect, I will be moving some of my HSA funds into my Roth IRA (then use $ in that for SS “bridge” living expenses) while more quickly liquidating my HSA to meet the goal of more simplification. That’s something I didn’t think of until reading your post. Thanks!
Makes sense. To my knowledge, receipts do not need to be submitted/filed. They are needed if audited, though.
Yes, you are correct! Thank you for clarifying that.
I was confusing our HSA accounts with our RHRA accounts (Retiree Health Reimbursement Arrangement).
The company that administrated our HSA’s encouraged account holders to upload copies of the documents that supported their claimed expenses. It was not mandatory, but it was suggested as a safe and secure way of maintaining supporting evidence in case of an audit by the IRS. I didn’t make use of that service but I can see why others might want to.
The company that administers our RHRA’s requires submittal of documentation.
I had a similar decision to make for the remaining HSA (Health Savings Account) balances we had accumulated during the years our medical insurance was from a HDHP (High Deductible Health Plan) while I was still actively employed and before I signed up for any Medicare coverage.
Our unused contributions and related earnings in our HSA accounts were unused for a number of years after I was no longer a participant in my previous employer provided HDHP and for a time after I retired and for the time period both my wife and I had been on traditional Medicare for a few years. We each had our own HSA.
Our decision regarding our HSA accounts was driven by a long term goal to simplify our finances where possible. After a few years of paying traditional Medicare Part B and Part D drug plan premiums on a after tax basis those accumulated premiums exceeded our combined HSA account balances and thus we could then distribute our entire HSA balances as a income tax free reimbursement and file the 8889 forms for each of us with our annual 1040 for the tax year we liquidated our HSA accounts. Expect a notice from the IRS if you make HSA distributions and fail to file the appropriate form(s) 8889 with your 1040.
Note that Medicare Part B & D premiums, and also COBRA premiums, are generally qualified medical expenses eligible to be reimbursed from a HSA account. The premiums for a Medigap supplemental policy or other medical plan insurance premiums are generally not eligible medical expense for tax free HSA reimbursement. The tax rules can be different if you are self employed and claim an above the line deduction for health insurance or if you itemize your deductions and claim a medical expense for any Medicare or COBRA premiums you paid. This is my understanding of current tax law. For financial advice, review official tax law and rules and/or consult a tax professional. I found the following unofficial linked article by Fidelity to be a readable summary-
https://www.fidelity.com/learning-center/personal-finance/hsas-and-medicare
A few years ago there was a failed federal legislative proposal to eliminate the Part B & D premiums as expenses eligible for tax free reimbursement that did not get enacted. That failed tax proposal worried me. Tax laws can and do change so plan accordingly. I also liked the tax certainty of getting the tax free reimbursement currently in making our decision in the event this part of the tax laws and rules change in the future.
The 2024 tax year draft 8889 form instructions have been released by the IRS and can be found here –
https://www.irs.gov/pub/irs-dft/i8889–dft.pdf
I hope this help in your decision.
Best, Bill Perry
Bill,
Thanks for expanding on the what Medicare-related premiums are eligible for HSA reimbursement. I was aware that my Medigap premiums are not eligible. Fortunately, I do just enough consulting work each year since retirement to write-off all my (and my spouse’s) “healthcare” premiums– including my Medigap, and my LTCI premium– as an “above the line” deduction… as you aptly pointed out. Given that, and our household’s remaining income that is largely non-taxable, my challenge is reporting enough MAGI to qualify my spouse for ACA so she doesn’t “fall into” Medicaid eligibility. I do this my adjusting my year-end Roth conversions to meet the target for highest ACA premium subsidy (and lowest OOP cost). According to the KFF.org ACA calculator, that will be about $40,300 for a household of two.
P.S. I to am on the quest to simplify our finances, so depleting the HSA account would serve that purpose.
With the additional information you provided I would add that an important additional tax consideration in managing your current year taxable income may be for you to also consider the additional qualified business income (QBI) deduction which is likely 20% of your net self employment income less 1/2 of your self employment tax and less your above the line health insurance premiums (I assume you do not have a solo 401(k) or other plan that reduces your QBI income). See IRS form 8995 and instructions to determine QBI income. Your focus on reporting enough MAGI to qualify your spouse for ACA so she doesn’t “fall into” Medicaid eligibility does appear to be the key tax factor in your planning for 2024.
I would think if you wanted to build a little cushion in your planning I would shoot high on your EOY Roth conversion in 2024 and then make a traditional or Roth contribution in 2025 for 2024 (maybe to your younger spouse tIRA or rIRA as she has a longer life expectancy) to hit the target taxable income you want for 2024 when you have all of your final 2024 amounts available to you.
I would also note that since you have not yet claimed your social security benefit that in the future years when you do claim you may find yourself in an effective higher tax bracket than the published table brackets due to each additional dollar of other taxable income can cause an additional $0.50 or $0.85 dollar of your social security benefit to be taxable income if you are in the lower tax brackets. In my managed taxable income I know my 2024 10% bracket rate becomes 18.5% effective rate(.10 x 1.85) and the 12% bracket rate becomes 22.2 % effective rate (.12 x 1.85). I do not have income in 2024 that will be taxed at capital gain rates to consider in my planning. The state I live in does not have a state income tax for me to consider.
I use the free AARP tax calculator to help plan our current tax year income which is good enough for me but there may be some good paid software tools available that lets you plan for multiple future tax years.
A financial goal for us is to minimize the present value cost of income taxes for my wife, me and our children as our heirs over the rest of my wife and my life. All of the unknowns make this kind of planning a difficult guess for all of us, but I never want to waste the zero or low tax brackets if I can avoid doing so. I assume my wife will outlive me by a number of years and I expect her marginal tax rate will be much higher after I am gone so I am willing to pay some tax now so hopefully her income tax after my death will be in her then single status of the then lower tax brackets and our children’s income tax on inherited assets are as close to zero as possible.
Good luck on your year end planning.
Best, Bill
I like your idea of “I would think if you wanted to build a little cushion in your planning I would shoot high on your EOY Roth conversion in 2024 and then make a traditional or Roth contribution in 2025 for 2024…to hit the target taxable income you want for 2024″.
In regards to my QBI deduction, I match my net consulting income to my expected medical insurance premiums and 1/2 FICA such that I really don’t have QBI-eligible income— I enjoy the consulting work, but I have other things I want to do in retirement.
The only real uncertainty in projecting our EOY income is our K-2 income from my spouse’s S-Corp. (she, and sometimes I, are its only employees). She does her best to estimate by December what the pass-through income (minus the QBI deduction) will be, but applying your suggestion related to making either/or Roth/Traditional IRA contributions in 2025 for 2024 gives me another tool to use.
Related to K-2 pass-through income….. this year the S-Corp will need to report I-bond interest from redemptions. My wife knows where it is to be entered on the S-Corp (1120S) reporting form that is the basis for filling out the K-2’s. But we are uncertain how this will be reflected on the K-2 “ordinary” income we will need to report on our 1040. That income is one component of our AGI which is the basis for calculating our federal and state taxes, but……. the I-bond interest is exempt from state taxation. The outstanding question for us as we determine our need to pay state estimated tax for Roth conversions: Do we lose that tax advantage for I-bonds held by an S-Corp?
“ I assume my wife will outlive me by a number of years and I expect her marginal tax rate will be much higher after I am gone so I am willing to pay some tax now so hopefully her income tax after my death will be in her then single status of the then lower tax brackets and our children’s income tax on inherited assets are as close to zero as possible.” Ditto!
Thanks,
“the other Bill”
What I seen in the past in a schedule K-1 received from an 1120-S in regards to I-Bond interest is that I-Bond interest earned during the year is not included on the federal K-1 in ordinary income K-1 line 1 but is included as part of K-1 line 4 interest income.
Typically where there are differences in taxable income between federal and state due to laws or rules there is a separate state K-1 where federal treasury interest income, including I-Bond interest, is adjusted out of the state/local taxable interest income on the state K-1.
Not knowing what state(s) you live in or what tax software is being used could impact the presentation on the K-1 but my understanding is that all US treasury interest income is exempt from state and local income taxation by federal law IRC 103.
See –
https://www.irs.gov/taxtopics/tc403
and
https://www.law.cornell.edu/uscode/text/26/103
Good article! I never thought to withdraw funds from an HSA, using prior year medical receipts, to bridge the gap to SS. Thanks Bill!
Distributions from an HSA for qualified medical expenses
“With an HSA, you are not required to take a distribution to reimburse yourself in the same year you incur a particular medical expense. The key limitation is that you can’t use an HSA balance to reimburse yourself for medical expenses you incurred before you established the account.
So keep your receipts for all healthcare expenses you pay out of pocket after you establish your HSA. If, in your later years, you find yourself with more money in your HSA than you know what to do with, you can use your HSA balance to reimburse yourself for those earlier expenses.”
qualified medical expenses: https://www.irs.gov/pub/irs-pdf/p502.pdf
Unless there’s some nuance I’m missing, I’d be inclined to spend down your HSA because of the restrictions on 1) how the money can be used tax-free (i.e. only for qualified medical expenses) and 2) the income-tax bill for non-spouse beneficiaries. I wouldn’t pay any attention to how the accounts are currently invested; you can always change that.
Thanks Jonathan. That is my inclination, but have always appreciated any nuances the HD community might provide.
I am in a similar situation and look forward to what others share about choosing between Roth and HSA accounts for withdrawals. My one comment, though, is I don’t think it matters much how the funds in the Roth and HSA are currently invested. For example, if you wanted to make your withdrawal from the HSA but prefer holding the short term government bond fund, you could purchase the bond fund in your Roth account.
Thanks for commenting, Kevin. For many years I had my HSA in equities, but had changed its allocation to short term bonds as I approached retirement knowing it could likely be one of the sources of funding (short term bucket) my living expenses during my SS bridge period. I will be interested in how you might utilize other’s potential comments as you move into a similar situation.