Balancing 401(k) and HSA Contributions

September 25, 2019

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
them. Determining how much to contribute to
each type of plan will require some careful
thought and strategic planning.
Understand the tax benefits
A traditional, non-Roth 401(k) allows you to
save for retirement on a pre-tax basis, which
means the money is deducted from your
paycheck before taxes are assessed. The
account then grows on a tax-deferred basis;
you don’t pay taxes on any contributions or
earnings until you withdraw the money.
Withdrawals are subject to ordinary income tax
and a possible 10% penalty tax if made before
you reach age 59½, unless an exception
applies.

You can open and contribute to an HSA only if
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. Although HDHP
premiums are generally lower than other types
of health insurance, the out-of-pocket costs
could be much higher (until you reach the
deductible). That’s where HSAs come in.
Similar to 401(k)s, they allow you to set aside
money on a pre-tax or tax-deductible basis, and
the money grows tax deferred.
However, HSAs offer an extra tax advantage:
Funds used to pay qualified medical expenses
can be withdrawn from the account tax-free.
And you don’t have to wait until a certain age to
do so. That may be one reason why 68% of
individuals in one survey viewed HSAs as a
way to pay current medical bills rather than
save for the future.1 However, a closer look at
HSAs reveals why they can add a new
dimension to your retirement strategy.

HSAs: A deeper dive
Following are some of the reasons an HSA
could be a good long-term, asset-building tool.
• With an HSA, there is no “use it or lose it”
requirement, as there is with a flexible
spending account (FSA); you can carry an
HSA balance from one year to the next,
allowing it to potentially grow over time.

• HSAs are portable. If you leave your
employer for any reason, you can roll the
money into another HSA.

• You typically have the opportunity to invest
your HSA money in a variety of asset
classes, similar to a 401(k) plan. (According
to the Plan Sponsor Council of America, most
HSAs require you to have at least $1,000 in
the account before you can invest beyond
cash alternatives.2 )

• HSAs don’t impose required minimum
distributions at age 70½, unlike 401(k)s.

• 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).

• Prior to age 65, withdrawals used for
nonqualified expenses are subject to income
tax and a 20% penalty tax; however, after
age 65, money used for nonqualified
expenses will not be subject to the penalty
[i.e., HSA dollars used for nonqualified
expenses after age 65 receive the same tax
treatment as traditional 401(k) withdrawals].

The bottom line is that if you don’t need all of
your HSA money to cover immediate
health-care costs, it may provide an ideal
opportunity to build a separate nest egg for
your retirement health-care expenses. (It might
be wise to keep any money needed to cover
immediate or short-term medical expenses in
relatively conservative investments.)

Additional points to consider
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: in
2019, the limits are $19,000 (plus an additional
$6,000 if you’re 50 or older) in your 401(k) plan;
$3,500 for individual coverage (or $7,000 for
families, plus an additional $1,000 if you’re 55
or older) in your HSA. Realistically, however,
those amounts may be unattainable. So here
are some important points to consider.

1) Estimate how much you spend out of pocket
on your family’s health care annually and set
aside at least that much in your HSA.

2) If either your 401(k) or HSA — or both — offers
an employer match, try to contribute at least
enough to take full advantage of it. Not doing so
is turning down free money.

3) Understand all HSA rules, both now and
down the road. For example, you’ll need to
save receipts for all your medical expenses.
And once you’re enrolled in Medicare, you can
no longer contribute to an HSA. Nor can you
pay Medigap premiums with HSA dollars.

4) Compare investment options in both types of
accounts. Examine the objectives, risk/return
potential, and fees and expenses of all options
before determining amounts to invest.

5) If your 401(k) offers a Roth account, you may
want to factor its pros and cons into the
equation as well.

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