If you were to search online for “HSA (aka health savings account) and 401(k),” some of the results might seem like there is a competition to determine which one is a better option when saving for retirement.
In my mind, there is no competition. Choose the 401(k) to save for living expenses in retirement; choose the HSA to save for medical expenses in retirement.
Ideally, choose both to build up monies that you will need after you retire. Why? It’s far too easy to underestimate the cost of medical care in retirement. Recent Fidelity studies (tinyurl.com/48cnt7ar) show that couples’ out-of-pocket estimated health care costs average $315,000, seven times more than people anticipate.
HSAs were introduced in 2004 (Internal Revenue Code Section 223 — tinyurl.com/mr2djpb9), 20-plus years after 401(k)s were established. Now, there are more than 32 million HSA accounts (2021), according to Devenir, an HSA investment adviser and industry consultant (tinyurl.com/285cwx5a).
HSAs are used to pay or reimburse qualified out-of-pocket medical expenses and are attached to high-deductible health plans (HDHPs).
Among the potential benefits of HSAs (from IRS Publication 969, tinyurl.com/2p9x5ytd) are:
You can claim a tax deduction for contributions you make to your HSA even if you don’t itemize your deductions.
Contributions to your HSA made by your employer may be excluded from your gross income.
Contributions stay in the account until used. (This is unlike a flexible spending account, or FSA, for which funds generally must be used by the end of the plan year.)
The interest or other earnings on the assets in the account are tax-free.
An HSA remains with you if you change employers or leave the workforce.
Both HSAs and 401(k)s have contribution limits. For 2022, the maximum HSA limit for an individual with HDHP coverage is $3,650. For family HDHP coverage, it is $7,300. (Note that if you are an eligible individual age 55 or older, you can contribute an additional $1,000.) According to Revenue Procedure 2022-24 (tinyurl.com/55xcywhu), individual coverage will be $3,850 in 2023, and family coverage will be $7,750.
Note that once you enroll in Medicare (generally age 65 or older), you cannot contribute to an HSA, although you can still use it to pay for medical expenses.
For 401(k)s, the contribution limit for 2022 is $20,500 (with a catch-up contribution of $6,500 for those age 50 and older). Generally, you can contribute to a company 401(k) if you are still working at that company, regardless of age.
How do HSAs factor into retirement discussions? Like the 401(k), contributions occur before retirement. While both traditional 401(k)s and HSAs are funded with pre-tax dollars, HSA withdrawals are tax-free for qualified medical expenses, while pre-tax 401(k) withdrawals are subject to income taxes.(Note that 401(k)s can also be funded with after-tax dollars.)
If you have limited funds, should you fund the 401(k) or the HSA? If you have a 401(k) with a match, contribute enough to maximize the match. Then consider the HSA.
In the alternative, you could max out HSA contributions every year and spend as little of the HSA money as possible so that you will have the funds to use for medical expenses once you retire. That would work for someone with a pension that covers retirement living expenses, but not others who need 401(k) savings.
Again, try to fund both. But be vigilant. The 2021 Employee Benefit Research Institute reported that 56% of workers who began contributing to an HSA reduced their contributions to a 401(k) (tinyurl.com/4j89n9za). You don’t want to reduce your 401(k) below the amount that maximizes the match.
When it comes to retirement, the goal is to save as much as possible for as long as possible. Both HSAs and 401(k)s can have important roles in your long-term planning. If you have both, learn as much as you can about each and then decide how they best fit into your overall plan for a long and healthy retirement.