Health Savings Account Arbitrage

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The Health Savings Account, or HSA was introduced in 2003 and has revealed itself to be a top choice in saving money on health insurance.  Beyond the obvious saving advantage that comes from empowering consumers to pay for most of their everyday medical expenses, the HSA also has a hefty tax benefit.  HSAs are free from federal tax when accumulating, compounding and distributing money (although some states, like California do tax it). And due to a ruling by the IRS, it's possible to accrue savings in your HSA to use as an emergency fund or regular savings account.  Call it "Health Savings Account Arbitrage"!

How Health Savings Account Arbitrage Works

Health savings account arbitrage: Picture of a $20 bill.

Using HSA Arbitrage can mean real money... if you're organized.

Normally, the tax benefit is only when using the HSA for qualified medical expenses.  After the beneficiary turns 65, non-qualified distributions are taxed at the normal tax rate, just like a traditional 401(k) or IRA.

Assuming the expenses would otherwise be taxed at a later date, the worker could pay all of their expenses post-tax.  The account would then compound over the years as the worker approached 65. Once 65, the account would solely be used for medical expenses, tax-free.  If the primary owner of the account dies, the account can be passed to a surviving spouse tax-free.  Any large medical expenses that cause cash flow problems can be reimbursed in an emergency.  Also, medical expenses not reimbursed could be ‘booked’ in order to later withdraw in a lump sum if needed - a strategy at the cornerstone of our Health Savings Account emergency fund strategy.

The HSA Arbitrage Strategy At Work: An Example

An example of this strategy in action would be (assume 4% growth, and $3,000 deposits and medical expenses per year, all inflation adjusted to speak using today’s money):

Book $30,000 in medical expenses in a 10-year period.  The contributions in that time would grow to $36,018.32 in today’s money.  You could then reimburse yourself $30,000, booking $6,018.32 in returns.

It certainly takes a bit of bookkeeping and solid record keeping, but if you're willing to stash receipts and keep a spreadsheet of your expenses for future payback it's a realistic way to build up a mass of funds for later consumption.  (Just ask us - since we started, we've booked five figures of medical expenses with the health savings account arbitrage strategy.).

So, what do you think - is health savings account arbitrage something you'd consider doing?  Are you already doing it?  Let us know your experiences and refinements!



PK started DQYDJ in 2009 to research and discuss finance and investing and help answer financial questions. He's expanded DQYDJ to build visualizations, calculators, and interactive tools.

PK lives in New Hampshire with his wife, kids, and dog.

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