If you have the opportunity to contribute to both a 401(k) and a health savings account (HSA), you may wonder how best to take advantage of both as part of your retirement plan. Determining how much to contribute to each requires careful thought and strategic planning. Here are a few of the primary considerations.
Understand the logistics
A traditional, non-Roth 401(k) allows you to contribute pretax dollars, meaning you don’t pay income taxes on your contributions in the year that you make them. The money in the account grows on a tax-deferred basis; you don’t pay taxes on any earnings until you withdraw the money in retirement, when withdrawals are taxed as income.
If you need to withdraw money before you reach 59½, you may need to pay a 10% penalty in addition to state and federal income taxes, unless you qualify for an exception as defined by the IRS.
You can only open and contribute to HSAs when you are enrolled in a qualifying high-deductible health plan (HDHP), are not covered by someone else’s plan, and cannot be claimed as a dependent by someone else. HSAs are similar to 401(k)s in that they allow you to set pretax dollars and the money grows tax-deferred.
HSAs offer an extra tax advantage, though. When you use the funds for qualifying medical expenses, you can withdraw the money tax free at any age. This is commonly referred to as a triple tax advantage.
Keep in mind, however, that taxes aren’t the only consideration. While high deductible health plans tend to come with lower premiums, but they may also come with higher out of pocket costs. Because of that, folks often use HSAs to pay current medical expenses, as opposed to part of their retirement savings plan.
Health Savings Account (HSA): A Deeper Dive
Following are some of the reasons an HSA could help you invest for retirement:
- HSAs don’t have a “use it or lose it” requirement. Unlike flexible spending accounts (FSAs), you can carry your HSA balance from year to year.
- HSAs are portable. If you leave your employer for any reason, you can roll the money into another HSA.
- Flexible investment selection. Typically, you can invest HSA funds in a wide array of assets, similar to a 401(k), though your investment options may be restricted until your account balance surpasses a minimum amount.
- HSAs allow you to withdraw money at any age so long as you use the money for qualified medical expenses. (If you use the money for nonqualified expenses before you turn 65, the IRS imposes a 20% penalty; after age 65, using the funds for nonqualifed expenses simply triggers income tax.
- You can use your HSA money to pay for certain health insurance costs in retirement, including Medicare premiums and copays, as well as long-term care insurance premiums (subject to certain limits).
- HSAs don’t come with required minimum distributions (RMDs) like 401(k)s and traditional IRAs do.
If you don’t need to use the money in your HSA for immediate health care costs, they can be an ideal tool for retirement planning. Learn more about the 2024 Key Numbers for Health Savings Accounts to make informed decisions.
Balancing contributions to your HSA and 401(k)
If you have the option to save in both a 401(k) and an HSA, ideally you would set aside the maximum amount in each type of account. (Like tax-advantaged retirement accounts, HSAs come with contribution limits. The limits are updated annually.)
Realistically, however, those amounts may be unattainable. Similarly, an HDHP might not make sense for you and/or your family depending on your health and medical care needs.
Generally speaking, it’s a good idea to prioritize your 401(k) first and then take advantage of an HSA only if a HDHP makes sense for your family. If that’s the case, we can discuss the best way to fund the account and manage your investments.
If you think an HSA might be a good option for you and your family going forward, set up a call with a Bogart Wealth expert to discuss.
