If you participate in a high-deductible health insurance plan offered by your employer, you may be sitting on one of the most powerful retirement accounts in existence and not even know it. A health savings account is a special tax-advantaged account only available for participants in certain high-deductible health plans.
If you have an HSA, you may want to max out your contributions to the account before saving in any other type of account, even a 401(k). The account has several advantages over a 401(k) that make it extremely attractive.
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Quadruple tax-advantaged
A 401(k) account and other retirement plans are tax-advantaged. They usually have two tax advantages: Contributions are tax deductible, and you won't pay taxes on capital gains or dividends in the account. Alternatively, you can pay taxes on Roth contributions and withdraw tax-free in retirement.
An HSA allows you to deduct your contributions, and any investments grow tax-free as well. On top of that, you can withdraw any amount for qualified medical expenses tax-free. So, money goes in, grows, and comes out, all tax-free.
And if you're able to contribute directly through your payroll, you also won't pay FICA tax on the contribution. Note, that'll have a small impact on your reportable Social Security wages, which will create an ever-so-slight reduction in Social Security benefits in retirement. You should be able to make up the difference by investing the tax savings.
The most flexible withdrawals
With a 401(k), you typically have to wait at least until the year you turn 55 to take a withdrawal without penalty. With an HSA, you can take withdrawals tax-free and without penalties at any time for qualified medical expenses. If you pay out of pocket and save your receipts from your medical expenses over the years, you can make one lump withdrawal up to the total sum of all your expenses.
That said, you may be better off leaving your money in the account as long as possible in order to maximize your tax-advantaged savings growth. That's especially pertinent because HSAs don't impose required minimum distributions, while 401(k)s are subject to RMDs starting at age 72. Older retirees can let their accounts keep growing indefinitely.
If you end up being lucky enough to not have enough medical expenses to withdraw from your HSA, you're able to take distributions for any reason without penalty starting at age 65. Unlike withdrawals for qualified medical expenses, your withdrawals will be taxed as ordinary income. But that simply puts the account on par with a traditional retirement account.
Freedom of choice
When you use a 401(k), your investment options are limited. You have to use a specified 401(k) provider, and you likely won't be able to invest outside of a select group of mutual funds.
An HSA is your account. You're free to move it to whichever broker you decide. Even if your employer requires you to deposit funds with a specific provider, you can move the funds over to your preferred servicer whenever you want. That gives you the ultimate freedom to invest your funds however you like, whether it's low-cost index funds or individual stocks.
That also means you can avoid the high fees often associated with 401(k)s. You should be able to find a provider that has no unnecessary administration or investment fees. (I'm a fan of Fidelity.)
The only drawbacks of an HSA vs. 401(k)
While the HSA has a lot of advantages over a 401(k), it's not a runaway winner.
First of all, the contribution limit on an HSA is significantly lower than a 401(k). Those on an individual health plan can contribute just $3,650 to an HSA in 2022, and those with a family plan can contribute $7,300. That includes any contributions your employer might make. So if your employer puts in any amount, it lowers the amount you could contribute.
Second, it's unlikely your employer offers a matching contribution. Most employers will offer a matching contribution for a 401(k), but fewer will contribute to your HSA. And if they do, it's more likely to simply put in a lump sum regardless of the amount you contribute. That reduces the incentive to prioritize the HSA over the 401(k). It's probably wise to max out the employer match on your 401(k) before prioritizing HSA contributions. Ideally, you can do both.
Even with these drawbacks, an HSA is a powerful savings account for retirement. It typically goes underutilized, but you don't have to let yours go to waste.
