Reimbursement Deadline Looming? Not Such Thing if You Own an HSA!

If your Health FSA plan year ends June 30 and you have a large balance unspent, you may be concerned that you may forfeit some of your election. Health Savings Account owners have no such concerns - ever.

It's part of the cycle of benefits. Health FSA plan years end. Perhaps your employer has added either a grace period or a carryover of unused funds to limit your forfeiting unused balances. These election extenders are useful, but they don't erase the fundamental issue: Health FSAs are annual plans with fixed beginning and end dates. And you risk forfeiting unspent balances if your qualified expenses are less than you projected or you've lost important paperwork. [Author's note: Health FSAs offer terrific tax savings and allow participants to spend their annual elections before they accrue. With proper projecting, participants can reap enormous benefits. Health FSAs fall short of Health Savings Accounts in flexibility and timing of reimbursements.]

How to avoid this annual stresser? Yes, your employer can help some with a grace period or a carryover. But those steps help at the margin - either giving you an additional two months and 15 days to spend your election or allowing you to carry over a portion of your balance into the new plan year. You still must fear the forfeiture.

HSA owners don't experience similar angst when their benefits renew annually. Why? Read on . . .

Reimbursement Deadlines

Health Savings Account owners face no deadlines to reimburse tax-free their qualified expenses during their lifetime. Once they establish their account, they can reimburse any subsequent qualified expenses on a schedule that fits them. Here are some common ways that owners manage their accounts:

Reimburse immediately. About five in eight Health Savings Accounts had balances of less than $1,000 at the end of 2021 (according to Devenir Research's 2021 End-of-Year Report). Most of those owners reimburse claims as quickly as they incur them. In effect, their Health Savings Account works like a Health FSA with some additional flexibility to alter their contributions as their needs change.

Delay all reimbursement. About 14% of accounts (roughly 4.2 million) have balances of $5,000 or more, including 2% (about 600,000 accounts) with balances north of $25,000. Many of these owners are presumably contributing to the statutory maximum, paying qualified expenses with personal funds, and actively building their Health Savings Account balances for distribution in retirement.

Take a hybrid approach. A subset of owners that's difficult to quantify blend the two approaches. They tend to pay small expenses with personal funds to retain their account balances for large expenses in the present or the future. They view their Health Savings Account as an emergency fund that contains the cash that they need to pay an unexpected (or even planned) large expenses at any point in the immediate or distant future.

The Benefit of Delaying Reimbursement

The best reason to delay reimbursement is that owners can build their balances to reimburse qualified expenses in retirement. Those distributions aren't included in retirement income. This tax treatment contrasts with withdrawals from tax-deferred 401(k) (and similar) plans and Individual Retirement Accounts, or IRAs. Withdrawals from those retirement accounts are always included in taxable income, even when the distribution reimburses a qualified expense. Thus, a $100,000 balance in a Health Savings Account has far more spending power than the same amount in a tax-deferred retirement account. At a 17% combined federal and state income tax rate, for example, the $100,000 balance in a tax-deferred IRA buys only $85,470 of good and services and the taxes associated with the withdrawal. The same distribution from a Health Savings Account buys $100,000 of qualified expenses.

This concept is important not only for purchasing power, but also extends to Medicare and Social Security. Medicare Part B and Part D premiums are heavily subsidized by taxpayers. Those subsidies are lower for higher income enrollees. Large distributions from a tax-deferred retirement account are included in taxable income. Also, the percentage of total Social Security benefits that count toward taxable income is affected by tax-deferred retirement plan withdrawals - but not Health Savings Account distributions for qualified expenses. Paying qualified expenses from a Health Savings Account rather than withdrawals from a tax-deferred account may mean that 50%, rather than 85%, of your annual Social Security payment is included in taxable income. If you receive $20,000 in Social Security payments (roughly the average benefit) in 2022, that's a difference of having either $10,000 or $17,000 of that amount subject to federal and state (if applicable) income taxes.

The Downside of Delaying Reimbursement

If you preserve funds to reimburse future expenses, the downside is small. You must remember to retain receipts from those expenses with your important tax papers for that year. But if you defer reimbursement and then want to make a large tax-free withdrawal from your Health Savings Account to buy a Harley-Davidson motorcycle and tour the country, you can do so. But you must have retained receipts for unreimbursed qualified expenses from years past to match against that year's large distribution.

For some people, that document retention can be a challenge. But let's make it easy: Print a summary of annual activity from your medical carrier's online portal (or retain a mailed year-end statement). A document from your insurer showing that you satisfied a $5,000 family deductible means that you incurred $5,000 of qualified expenses that were your financial responsibility. Unless you reimbursed a portion of those expenses through a Post-Deductible HRA or a Limited-Purpose Health FSA that expanded to include all qualified expenses once you met the statutory minimum annual deductible for your contract tier, you can reimburse $5,000 tax-free at any point in the future.

Then gather and file explanations of benefits for large dental expenses. These documents show how much you owe after insurance pays. And be sure to save receipts for contact lenses and prescription glasses. If you make bulk purchases of qualified expenses online (by shopping at FSA Store/HSA Store or through Amazon), it's easy to print and retain those receipts.

But it's much more challenging to keep up with the weekly trips to the pharmacy and your sporadic purchase of qualified expenses on receipts that include greeting cards, candy, toothpaste, and laundry detergent. And the ink on those receipts often fades quickly, so you may end up with blank paper years from now if you want to batch and reimburse today's qualified expenses in the future.

The Bottom Line

Thus the beauty of a Health Savings Account versus a Health FSA. No need to stress over filing last-minute claims to reimburse qualified expenses not purchased with the attached debit card or forever lose access to your payroll deductions. Health Savings Accounts are forever accounts. You can't always contribute, but once you've established your account, you can reimburse today's expenses today, tomorrow, next year, or decades hence. No sweating claims-submission deadlines.

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