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HSA vs. 401(k)


Two of the most common vehicles for building savings are the 401(k) and the health savings account, or HSA. While the HSA isn’t a traditional retirement account, at least not formally, it can provide you with significant value when your healthcare costs likely rise in retirement. That helps it to serve as a useful backup to more ordinary retirement planning tools, like 401(k)s and IRAs. Consider working with a financial advisor as you pursue your retirement goals.

What Is a 401(k)?

A 401(k) is a tax-advantaged retirement account. Along with the IRA and Roth IRA, a 401(k) is one of the three main ways that the IRS tries to encourage individuals to save for retirement.

The IRS allows you to deduct every dollar that you contribute to a qualifying 401(k) from your annual income taxes. This allows you to pay no taxes on the money which you put aside from retirement. You do, however, have to pay taxes on this money when you withdraw it later in life.

The IRS also sets an annual cap on tax deductible contributions to a 401(k). In 2022, you can’t contribute more than $20,500 for 2022, with this number jumping to $22,500 in 2023. For those who are 50 or older, the IRS allows extra “catch-up contributions,” which can total up to $6,500 for 2022 and $7,500 in 2023.

A 401(k) is an employer-run retirement plan. Traditionally this means that it is only for workers who have an employer of some sort. While individuals who have their own business can set up a 401(k) for themselves, freelancers and the self-employed have not historically been able to set up a traditional 401(k). However in recent years this has begun changing, as investment firms have begun offering group 401(k) plans onto which individuals can enroll.

Generally speaking, an employer will structure their 401(k) plans as a traditional investment portfolio, though investments are limited. In fact, they usually consist of target-date funds, which are pools of investment that change based on how close you are to retiring.

These portfolios are managed either by the employer directly or by a financial management firm that the employer chooses. Some employers contribute to their employees’ 401(k) plans as well. This is not necessary, but employers receive a tax break as well if they contribute to employees’ retirement accounts.

What Is a Health Savings Account (HSA)?

HSA vs. 401(k)

A health savings account or HSA is a form of tax-advantaged savings account that was originally built to help people set aside money for medical expenses. This is particularly relevant as people save for retirement, given that medical expenses tend to increase with age.

You can only enroll in an HSA if you are enrolled in a high-deductible insurance plan. This means that your health insurance only begins to pay for your medical expenses after you have paid a significant portion of your medical bills out of pocket. The IRS defines high-deductible plans as $1,400 for individuals and $2,800 for families. If your health insurance changes, you can keep an existing HSA but may not deduct any contributions you make to it while carrying a non-high-deductible plan.

An HSA is structured very similarly to a 401(k) and in fact many employers offer these plans to their employees. Most accounts are set up as an investment portfolio with a mainstream mix of mutual funds. Although some HSA accounts offer a simple savings account with modest interest, and are built just to help people set aside money rather than to help them grow these funds.

You can contribute to this account at your discretion, although if you have an employer-run HSA they may allow you to contribute a fixed amount from your paycheck. Some employers will make contributions to employees’ HSA funds as well, again similar to a 401(k), but this is relatively uncommon.

Unlike a 401(k) you can open an HSA on your own if your employer does not offer one. (Again, readers should note that it is becoming easier for individuals to find 401(k) programs, but this is a relatively new development.)

Like a 401(k) you can deduct all of the money you put in an HSA account from your federal income taxes, making the money you save for medical expenses federally tax-free. Also like a 401(k) the IRS places an annual limit on contributions. For 2022, these limits are $3,650 for individuals and $7,300 for families. These limits will rise to $3,850 and $7,750 in 2023. There is an extra $1,000 allowed for those 55 and older. Past these points, you may still contribute money to most HSA accounts, but you cannot deduct the additional contributions.

Using an HSA as a Backup for Your 401(k)

A health savings account has three basic rules for withdrawal:

  • Medical Expenses: If you withdraw money from an HSA to pay for medical expenses you do not pay taxes on your withdrawals. In this case you effectively have completely tax-free money to help pay for your medical expenses. While you must have a high-deductible insurance plan to make contributions to an HSA, you can withdraw this money even if you have a better insurance plan later in life.
  • Nonmedical Expenses, Before Retirement: The IRS charges a steep 20% penalty if you withdraw money from an HSA to pay nonmedical expenses and you are younger than age 65. In that case, you must pay both income taxes on the money you withdraw and the penalty.
  • Nonmedical Expenses, After Retirement: If you withdraw money from an HSA after age 65 for nonmedical expenses you do not have to pay any penalties. You do have to pay regular income taxes on the money you withdraw, however.

It’s this last point that allows HSA programs to function as a form of supplemental retirement plan for some people. During your working life the tax rules for contributing to an HSA are identical to a 401(k) but with a smaller annual cap. Once you are past retirement age, the rules for withdrawing money from an HSA are also identical to withdrawing money from a 401(k). As a result, if you are eligible to open an HSA during your working years, you can effectively use this as a second retirement account.

For people looking to boost their retirement savings this can be an excellent way to get a little more mileage out of tax-advantaged programs. This is particularly useful for workers who are in their younger years. People in their 20s often can get away with taking high-deductible health plans (as long as they are absolutely certain they can afford to pay that deductible in case of a medical emergency). For this cohort, it can often be wise to open a health savings account and store money there while young and healthy. Then, as you grow and transition to a more comprehensive insurance plan in your 30s, you can simply leave that HSA alone to accrue value decade after decade.

Bottom Line

A health savings account is a tax-advantaged form of investment that allows people with high-deductible health insurance to set aside money without paying taxes on it. If you don’t end up needing this money to pay for healthcare, by the time you hit retirement age it can also act as a nice supplement to your retirement savings.

Tips on Retirement Planning

HSA vs. 401(k)
  • Planning for retirement is stressful. Fortunately, financial advisors can offer a wealth of options for saving up during your working years. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Our free retirement calculator will help you determine how much you need to save for retirement. Planning ahead for this can be extremely helpful in the long run.

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