HSA vs 401k: How to Prioritize Your Retirement Investments

October 7, 2020

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When it comes to investments, it can be hard to know where to start. That’s especially true when it comes to investment options that not everyone knows about. In this guide, we breakdown all things HSA vs 401k to help you see how you might consider prioritizing your investments.

Created in the 1970s, the 401K is now a household term, with nearly 60% of the American workforce having access to them. However, there’s a new kid on the block. The HSA was born in 2003, and many of us are just starting to hear about this investment option. To learn more about the lesser-known HSA, I sat down with Shandon Fowler from Starship HSA.

Let’s explore how both 401ks and HSAs can help your financial future. 

HSA Overview

A health savings account, or HSA, is a specific type of savings account that allows individuals to set aside money to pay for medical expenses. Individuals fund these accounts with pre-tax money. Afterwards, individuals pay for qualifying medical expenses with that money. 

Some instances of when you may be able to use your HSA include:

  • Doctor visits
  • Surgeries
  • Over-the-counter medications
  • Prescriptions 
  • Femine hygiene products
  • Massage and chiropractic care
  • Contacts and eyeglasses

One thing Shandon emphasizes is making sure that your expenses are covered.

Let’s learn more about the advantages and disadvantages of an HSA to see if this account might be the right investment tool for you. 

HSA Advantages

One of the biggest benefits to the HSA is that it is a triple tax-advantaged account. According to Shandon, that means that the health savings account allows you to save tax-free, invest tax-free, and spend tax-free. HSA users put money in from a payroll deduction and it continues to grow tax-free. Then, if users follow IRS regulations when spending the money, that money is never taxed. 

Shandon also points out that the HSA can be both a short-term and long-term savings option. An HSA allows you to build up money to cover your immediate healthcare expenses. This is especially important with a high-deductible health plan as your deductible amount can be significant. 

In addition to covering short-term expenses, HSAs can help in the long term. You can save your expense receipts for as long as you’d like. While you save your receipts, your money is growing tax free inside your HSA investments. Then, you can submit your receipts after 5, 10, or even 30 years to claim all of that money to use in retirement. 

Along with the receipt hack that some people use, HSAs in general can be instrumental in offsetting the astronomical healthcare costs that many people face at the traditional retirement age and beyond. Though you can no longer contribute to an HSA once you turn 65, you can continue to withdraw money as needed. 

HSA Disadvantages

When it comes to the HSA vs 401k, there is one big drawback to the HSA account. Your contributions are much more limited with an HSA. In 2020, an individual can contribute $3,550 per year ($3,600 in 2021). A family can contribute $7,100 ($7,200 in 2021). This lower contribution threshold means that you have less investing opportunity compared to a 401k. 

Other HSA disadvantages center on eligibility. While many people talk excitedly about HSAs, it is important to note that only people who have a high-deductible health plan (HDHP) qualify for an HSA. 

It is also important to note that some HSA companies can come with higher fee structures. Much like your 401k or any other investment account, paying attention to those details can help you keep more of your money working for you. 

401k Overview

workplace benefits

A 401k is another investment vehicle that holds your investments. Unlike an HSA that can be used both now and later, a 401k is specifically geared toward retirement savings. A 401k plan can be either traditional or Roth, meaning that you either contribute pre-tax or post-tax money into your account. This investment option is employer-sponsored, meaning that a 401k is a benefit provided by your workplace.

Explore the advantages and disadvantages of an 401k to see if this investment vehicle fits your financial needs.

401k Advantages

One of the best parts of 401ks is how widely available they are. According to Shandon, there are no other prerequisites to having a 401k other than employment. That means that many more people are currently eligible for a 401k than an HSA.

Additionally, you can also contribute a more significant amount of money to your 401k compared to an HSA. In 2020, you can contribute up to $19,500 according to the IRS. There is also a catch-up provision that allows people over the age of 50 to contribute an additional $6,500. 

Another part of the 401k that helps it stand out from many investment vehicles is that employers often match a certain dollar amount or percentage of your contributions. Hypothetically, that might mean if you invest $1,000, your employer will also contribute that amount into your account. Of course, there are total contribution limits set by the IRS that both you and your employer have to follow. 

401k Disadvantages

Unlike HSAs, you cannot generally tap your 401k to cover current expenses without incurring a penalty. Legislation passed during the pandemic temporarily allowed for some flexibility there. However, most personal finance experts advise against taking money from your retirement account to pay for the present day. 

Another issue that some people may face with 401ks is the income limits. If you are what the IRS considers to be a highly-compensated employee, you might be subject to restrictions in terms of what you can contribute. 

Other things to be aware of when it comes to 401k investments are related to additional costs. Making sure that you are aware of associated fees and even one-time charges related to certain investment funds can help you keep more of your money working toward your retirement. 

HSA vs 401k 

typing on laptop

When it comes to knowing which investment vehicle might be right for you, it is helpful to consider other aspects of the account. In the breakdown below, we detail everything from tax advantages and ease of use to employer match and fees of HSAs and 401ks.

Tax Advantages

As Shandon emphasizes, your HSA gets special tax treatment. It’s triple tax advantaged because the money you contribute is tax free. Plus, your HSA investments can grow tax free and can also be used tax free. Like all investments, though, you have to adhere to the guidelines to avoid incurring penalties.

The 401k is not triple tax-advantaged. Instead, a traditional 401k can help you lower your adjusted gross income for the current year. However, your money is taxed in retirement. Conversely, a Roth 401k is funded with post-tax dollars, meaning what you withdraw in retirement is tax-free. 

Learn more about how I'm taking full advantage of all the tax advantages of an HSAs here.

Ease of Use

401ks probably win the prize in terms of ease of use because they are the investment vehicle that most Americans are familiar with. That means that not only are workers already at least vaguely familiar with the concept, there is also a vast range of options in terms of where and how you invest your money. One drawback to the 401k is that you cannot use the money until retirement without incurring a penalty.

HSAs, especially through apps like Starship, can also be really easy to use. You make your contributions electronically like any other online deposit and then can use a debit card for qualified expenses. Of course, you can also use your HSA now and later in life. 

However, since HSAs are new, there is still some confusion surrounding them. For instance, some people think of an HSA like a flexible spending account, or FSA. They then mistakenly believe that an HSA is a use-it-or-lose-it account. Shandon points out that HSA money is free to grow throughout your entire life. 

Employer Match

When it comes to 401k accounts, there is often an employer match. Shandon points out that many people consider this “free money”. What this employment benefit means is that your workplace will match a certain amount of what you put into your 401k. 

While HSAs do not have employer matches, there are many workplaces that contribute to the account. In fact, Shandon says that many employers cover at least some of the first-dollar expenses to help you pay your medical expenses until you reach your deductible. Common numbers include $1,000 or $1,200. 

Investing Options

In the HSA vs 401k shakedown, investing options are similar. The one benefit of an HSA is that you should have more flexibility in terms of choosing which company or app you open your account with. Still, both the 401k and HSA allow you to make regular contributions from your paycheck and have investing thresholds.

Learn more about investment strategies that you might use for both accounts here.

Fees

When it comes to HSA vs 401k debate, both investment types sometimes force you to contend with high fees. Fortunately, there are low-fee options through index funds. To avoid these fees, investors need to do their due diligence, researching fee structures, and other costs before opening an account.

Final Thoughts on HSA vs 401k

Many individuals are trapped with analysis paralysis when it comes to investing. They spend so much time contemplating the best move that they delay making any move. 

To help you move forward with the HSA vs 401k debate, consider your eligibility for the two investment types. Then, you might start by reviewing your matching options. If your company offers a 401k match, then you may want to try to contribute enough to get the match each year. After that, you may also consider funding an HSA, especially if your employer is also contributing to that account.

Both accounts are something that your future self will thank you for. So maybe when it comes to the HSA vs 401k battle, it’s really a tie. 



Andy Hill

Andy Hill is the award-winning writer, speaker and podcaster behind Marriage, Kids and Money - a platform dedicated to helping young families build wealth and thrive. Andy's advice and personal finance experience has been featured in major media outlets like Business Insider, MarketWatch, Kiplinger’s Personal Finance and NBC News. Trusted as a personal finance influencer and corporate financial wellness speaker by global brands like JLL, Andy’s message of family financial empowerment has resonated with listeners, readers and viewers across the world. When he's not "talking money", Andy enjoys wrestling with his two kids, singing karaoke with his wife and watching Marvel movies.

One Comment

  • The question is not HSA v. 401(k).

    The answer is contribute to your HSA first and then your 401(k).

    Employers need to contribute to the HSA, for certain. Don’t be afraid of the High Deductible! The minimum requirements for an HSA-eligible High Deductible Health Plan state that an Individual must have an annual deductible of $1,400. For a married couple, a single-parent with one or more children or a married couple with one or more children, the deductible must be at least $2,800. In 2020, that’s relatively peanuts. An unexpected hospital stay, testing, medicines, doctors, nurses, et al will blow through your deductible, coinsurance and out of pocket maximum like a hot knife through butter…into the tens of thousands of dollars, more than likely.

    Further, the HDHP should have an option for 100% coinsurance. That means that the insurance plan picks up ALL costs after the deductible has been met. The insured pays nothing more than the deductible. And the deductible is paid by the money saved in the Health Savings Account. If funded properly, no one should have any unexpected annual expenses due to an unexpected health insurance claim.

    Total Out of Pocket expenses for an HDHP w/100% coinsurance can easily be 50% less than traditional PPO/HMO plans. Depending on your plan, that could mean $1,000s of dollars staying in your pocket and not going to the insurance plan!

    It is easy to budget. It is easy to fund.

    Andy, let’s say someone is in the 24% marginal tax bracket. In a traditional plan with an individual deductible of $1,500, that person would likely pay the deductible from their checking account. Given a 24% tax bracket, that person would have to earn $1,973.68 and then pay Uncle Sam $473.68 and then pay the $1,500 deductible to pay the doctor, hospital, pharmacy and/or other provider.

    If that same person had an HSA that was properly funded, they would save themselves the $473.68. The $1,500 deductible is paid from the HSA. Simple. And saves the insured lots and lots of money over the course of their entire life. Why go to work for the tax man when you can work and earn for yourself and your family?

    What’s more, if you have no claims, you still save money every year because the premiums for High Deductible Health Plans are typically 10% less than a traditional plan, at the very least.

    HSA FIRST. Then worry about your 401(k).

    Reply

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