When we start to think about retirement savings, most of us think of a 401(k) or an IRA as the primary vehicle that we will use to achieve our retirement goals. But there’s another account that not enough people are taking advantage of that could be more beneficial in the long run and that is a Health Savings Account (HSA).
While an obvious advantage of a 401(k) is that many employers offer to match your contributions - hello, free money! - once you’ve contributed enough to maximize any employer matching, contributing money to an HSA is always going to be a better choice when it comes to planning for retirement.
We know you’re probably thinking… “What? That doesn’t even make sense. Aren’t HSAs meant to help with medical bills?”
While that is true, an HSA can also be used for much more. From significant tax advantages to having access to your funds now, we’ll run through 4 reasons why an HSA is better for retirement savings than a 401(k).
Reason #1: A “Triple Tax Advantage” is better than a “Double Tax Advantage”
The most obvious reason that an HSA is a better savings vehicle than a 401(k) is because the tax advantages are just better.
When you contribute money to a 401(k), you don’t pay income taxes on your contributions and you don’t pay capital gains taxes on any earnings that come from investing those funds. This is known as a “double tax advantage”.
HSAs share these advantages, but they also include a third one: You don’t have to pay taxes when you withdraw HSA funds. This is why it's known as a “triple tax advantage”.
Additionally, while your 401(k) funds will be taxed at whatever your applicable income tax rate is at the time, your HSA withdrawals are tax free as long as you use them to cover “Qualified Medical Expenses.” The list of qualified expenses can include things like:
- Medicare premiums
- Out-of-pocket costs
- Dental insurance
- Vision insurance
- Nursing Home costs
These are all things that can eat up a lot of your budget in retirement. In fact, Fidelity estimates that a couple retiring now can expect to spend $285,000 on health care expenses in retirement. Health care costs have historically outpaced general inflation, so that amount will only continue to grow over time (especially if you are younger). What’s more, this estimate doesn’t even include things like dental care or potential long-term care costs, which can also use a lot of your retirement budget.
Since it is inevitable that you will spend quite a bit on Qualified Medical Expenses as you grow older, you might as well leverage the triple tax advantage that you get from an HSA.
Last, what’s great about an HSA is that even if you don’t use your HSA savings on Qualified Medical Expenses, you’re no worse off than if you had put that money in a 401(k). Why? Because that withdrawal will be taxed just like a 401(k) withdrawal.
In fact, you’ll actually be better off putting money in an HSA even if you have absolutely no intention of ever using those savings for Qualified Medical Expenses. Keep reading to learn why.
Reason #2: HSAs have a less discussed fourth tax advantage
That’s right, HSAs have more than just three tax advantages. There is a fourth tax advantage that isn’t mentioned as often, but is still important when considering retirement planning.
When you put money into a 401(k) or IRA, you still have to pay Social Security and Medicare taxes on those contributions. However, if you contribute to an employer-sponsored HSA through payroll deductions, you get to avoid paying these taxes.
This means that, depending on how much you earn, your contributions to an HSA can net you an additional 7.65% tax break - that adds up!
Reason #3: HSA funds are available now, without penalty
Saving in a 401(k) is great, but one of the drawbacks is that if you find yourself needing access to cash, you’ll have to pay a penalty if you access your funds before you turn 65.
If you find yourself in a situation where you need access to fast cash, there’s a good chance that it’s because you are facing high, unexpected medical bills. In fact, it’s estimated that more than 60% of all bankruptcies are caused by medical issues. But not to worry, because HSAs help you save for exactly those types of scenarios.
When you put money in an HSA, you can access those funds at any time to cover Qualified Medical Expenses without being subjected to taxes or penalties. So when it comes to actually using your funds, saving in an HSA gives you more options.
Reason #4: No distribution requirement by age
Another advantage of HSAs is that they do not have age-related minimum distribution requirements. This gives you a lot more flexibility when it comes to tax planning in retirement.
When you contribute to any employer sponsored retirement plan, including a 401(k) or an IRA, you are required to take a minimum distribution at age 70 ½ - whether you want to or not. These funds are then added to your taxable income. If you reach this age and do not take the required minimum distribution, then that amount that you should have taken is taxed at 50%. Pretty crazy, right?
Luckily, with an HSA, you can invest funds until the day your Medicare coverage starts, and you are not required to take a distribution. At all. Ever. That means you can continue to grow your funds and use them as needed without having to worry about moving the money around in order to meet certain requirements. You also don’t have to worry about additional required distributions pushing you into a higher tax bracket. It’s a win-win.
To sum it all up, there are advantages to both an HSA and a 401(k), but when comparing them side by side, an HSA just makes better financial sense. You can invest funds the same way you would with a more traditional 401k but you experience better tax advantages and more flexibility with the money you’ve invested. Wex recently created a simple comparison chart which we’ve recreated below so you can see exactly how they stack up.
Are you still unsure what a health savings account actually is, or how much you should be contributing? Picwell’s new innovative feature, Interactive HSA, can help you (and your employees) learn more about the short and long-term benefits of investing in an HSA. Visit www.picwell.com/interactive-hsa to learn more and schedule a demo.