Why You Should Max Out Your HSA Before Putting More in Your 401(k)

Contributions to both a 401k or an HSA will reduce your overall taxable income. In that respect, they are both beneficial from a tax savings perspective. Funds contributed to a 401k account will be automatically invested in your selected investment allocation.

Funds that are contributed to an HSA will not be automatically invested unless you set up the account to do so. Most HSAs require a balance of somewhere around $1,000 in cash and then any value above that level can be selected to invest in the fund offerings.

HSAs have the most value as an investment vehicle for folks who can typically pay their regular medical expenses from cash flow and leave the value of the HSA funds invested. This allows you to essentially grow a Roth account for healthcare as you can pull funds from an HSA tax-free as long as they are utilized for qualified health care expenses. A 401k is simply tax-deferred in that you will eventually pay ordinary income tax on all distributions when you are retired.

HSAs can be very helpful for those who are planning to retire before age 65 when they are eligible for Medicare. Private health insurance policies pre-Medicare that are not employer-sponsored can be quite pricy.

1) Who benefits most from an HSA plan?

An HSA generally is appropriate for those with a high deductible healthcare plan. This would normally be recommended if your healthcare expenses are comparatively low, and you can afford to pay your expenses out of pocket.

2) When does it make sense for someone to invest more in their HSA vs. another savings vehicle like a 401(k)?

An HSA provides more tax benefits than a 401(k) as it’s triple tax-free. (You can contribute money tax-free, your money can grow tax-free, and you can withdraw money tax-free (as long as you have qualified medical expenses.) If you are willing to treat your HSA as a retirement savings account, I would argue that, as long as you are contributing enough to your 401(k) to earn any company match, it should be your first option for retirement savings (again after earning the company match).

3) Is there anyone who shouldn’t use an HSA plan?

You are not eligible for an HSA once you start receiving your healthcare benefits through Medicare. If your expenses are significantly high and a more conventional healthcare plan is more appropriate, then you shouldn’t use an HSA.

4) How do financial advisors help their clients with HSA plans?

Advisors can help clients invest the money in their HSA plan. They can also help them understand the tax benefits that come with an HSA. I have had clients tell me that they totally changed the way they treat their HSA once I explained the tax benefits to them as discussed further in this article we prepared about the benefits of HSA plans.

I work with professional women and dual-career couples in their 30s and 40s, and a high-deductible healthcare plan that offers a Health Savings Account (HSA) is typically a great fit for these millennial-generation families.

Most of the companies my clients work for offer a competitive HSA match if they choose the high-deductible healthcare plan, so I often advise clients to go with this option to take advantage of this free money and powerful tax-free investment account.

Oftentimes these younger clients don’t go to the doctor’s office much themselves apart from well-checks anyways so their healthcare spending is fairly low. If a couple does have younger kids who do tend to need more care in the early years, they’re able to pay for healthcare costs out-of-pocket with a credit card. I advise them to track of those expenses and maintain copies of their receipts so they can eventually pay themselves back from their HSA account.

When it comes to comparing the 401k to the HSA, ideally I’d want clients to contribute enough to their 401k so they receive the full company match if that’s available to them. Apart from that, if they have the ability to save more, we aim to max out their annual contribution limit into the HSA next before adding any more money into their 401k; For a family, this limit is capped at $7,500 (employee + company contributions) for 2023. HSA money receives triple tax savings, unlike any other retirement savings account like a 401k, Roth 401k, IRA or Roth IRA. Money goes in tax-free, grows tax-free while it’s invested, and then you don’t pay any taxes on the money when it comes out as long as you’re using the cash for qualified medical expenses.

Getting cash into the HSA is only the beginning. From there, I help clients look through their investment options and decide on an asset allocation for these funds that aligns with their overall investment plan. I also help with monitoring and rebalancing the account as needed.

1.) Anyone enrolled in a qualified high-deductible health plan can contribute to an HSA. These savings vehicles tend to work best for young, healthy individuals who have time on their side to let contributions grow tax-free over decades. 2.) As far as tax-advantaged savings vehicles are concerned, HSAs are at the top of the list (they’re like a tax-deferred account combined with a tax-free Roth account). Company matches on a qualified plan like a 401(k) would be about the only savings play that would trump an HSA. Some employers will contribute to an employee’s HSA as a form of tax-free compensation. 3.) If you’re enrolled in Medicare, then you cannot contribute to an HSA, but you can still use funds in the HSA to pay for qualified medical expenses. I think everyone should look into an HSA and, if eligible, use them to full effect. 4.) Financial advisors can help educate clients on the myriad advantages of using HSAs as a long-term savings and/or investment strategy. They can also help clients find suitable HSA custodians, if needed.