Investing

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

By  Kelley Long

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For people with very low healthcare costs, putting the maximum into Health Savings Account (HSA)-eligible healthcare plans is almost a no-brainer. This is especially true when their employer contributes to their account to help offset the deductible.

If you don’t spend that money, it’s yours to keep, and it rolls over year after year for when you do eventually need it, perhaps in retirement to help pay Medicare Part B or long-term care insurance premiums. 

“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,” said Kelly Klingaman, CFP®, RLP®, Founder & Financial Planner at Kelly Klingaman Financial Planning. “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 401(k).”

Should You Max Out Your HSA Even If You’re Not Super Healthy?

Even if you have higher healthcare costs, HSAs can still be a great deal. I reached the out-of-pocket maximum in my healthcare plan a few years ago, and yet I continue to choose the high-deductible plan solely because I want the ability to max out my HSA contribution.

Those looking to reduce taxable income appreciate the ability to exclude annual contributions from taxes up to the limitations set by the Internal Revenue Service (IRS). Here are the contribution limits for family coverage (add another $1,000 to the figures below if aged 55 or older):

  • Calendar Year 2023: $7,750
  • Calendar Year 2022: $7,300
  • Calendar Year 2021: $7,200

HSAs offer Even More Tax Benefits than your 401(k)

I don’t know why someone wouldn’t choose to max out their HSA before funding their 401(k) or another retirement account beyond their employer’s match. The HSA rules make it a much better deal. The funds can carry over indefinitely with the triple tax-free benefit of funds going in tax-free, growing tax-free, and coming out tax-free for qualified medical expenses.

Healthcare costs are one of the biggest uncertainties both while working and in retirement. A large medical expense for people without adequate emergency savings often leads to 401(k) loans or, even worse, early withdrawals, incurring additional tax and early withdrawal penalties to add to their financial woes.

Savings to an HSA not only means funds available when such expenses come up, but participants save on taxes rather than cause additional tax burdens.

“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),” said Ryan Firth, founder and president of Mercer Street Personal Financial Services

“Company matches on a qualified plan like a 401(k) would be about the only savings play that would trump an HSA. (However), some employers will contribute to an employee’s HSA as a form of tax-free compensation,” he added.

Heading Off Future Medical Expenses

The same consideration goes for healthcare costs in retirement. Having tax-free funds available to pay those costs rather than requiring a taxable 401(k) or IRA distribution can make a huge difference to retirees with limited funds.

Should you find yourself robustly healthy in your later years with little need for healthcare-specific savings, HSA funds are also accessible for distribution for any purpose without penalty once the owner reaches age 65 – a lot of people don’t realize this little nugget.

Non-qualified withdrawals are taxable, but so are withdrawals from pre-tax retirement accounts, making the HSA a fantastic alternative to saving for retirement.

Making the Most of All Your Savings Options

To summarize, when prioritizing long-term savings while enrolled in HSA-eligible healthcare plans, I would strongly suggest that the order of dollars should go as follows:

  1. Contribute enough to any workplace retirement plan to earn your maximum match.
  2. Max out your HSA (See Contribution Limits Below).
  3. Finally, go back and fund other retirement savings like a Roth IRA (if you’re eligible) or your workplace plan.

Contributing to your HSA via Payroll versus Lump Sum Deposits

Remember that HSA contributions can be made via payroll deduction if your plan is through your employer, and contributions can be changed at any time. You can also make contributions via lump sum through your HSA provider, although funds deposited that way do not save you the 7.65% (Federal Insurance Contributions Act) FICA tax as they would when depositing via payroll.

Financial advisors can also help clients by advising on the best way to invest their HSA for long-term growth, as long as the client has sufficient savings outside of the HSA to weather healthcare costs that come up during their working years. I think the HSA is one of the most powerful wealth-building tools available to people who can afford to contribute the maximum amount and avoid spending down their account on small expenses.

The bottom line is that when deciding between HSA healthcare plans and other plans, there’s more to consider than just current healthcare costs, and it often makes sense to max out your HSA.

An HSA can be an important part of your long-term retirement savings and greatly impact your lifetime income tax bill. I know it’s a big part of mine, despite having relatively high healthcare costs for someone my age.

Ask the Experts: Financial Advisors Share Smart HSA Strategies

For additional insights, we invited financial advisors in the Wealthtender community to offer their perspectives on the benefits of Health Savings Accounts. Here’s what they said:

Elizabeth Alf, CFP® Enlightened Financial Planning

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.

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Elizabeth Alf, CFP® | Clerestory Advisors

Philip Weiss, CFA, CPA Helping people invest with purpose, information, and confidence.

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.

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Philip Weiss, CFA, CPA | Apprise Wealth Management

Kelly Klingaman, CFP®, RLP® Financial Planning for Professional Women & Dual-Career Couples

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.

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Kelly Klingaman, CFP®, RLP® | Kelly Klingaman Financial Planning

Ryan Firth, CPA/PFS, CFP®, CCFC, GFP (USA), RLP® Think of us as your personal financial Sherpa on your life’s journey.

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.

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Ryan Firth, CPA/PFS, CFP®, CCFC, GFP (USA), RLP® | Mercer Street Financial


HSA Contribution Limits 2023

Each year, the IRS sets the maximum contribution amount for HSAs. For calendar year 2023, here’s the detail directly from Internal Revenue Bulletin: 2022-24 PDF):

Annual contribution limitation. For calendar year 2023, the annual limitation on deductions under § 223(b)(2)(A) for an individual with self-only coverage under a high deductible health plan is $3,850. For calendar year 2023, the annual limitation on deductions under § 223(b)(2)(B) for an individual with family coverage under a high deductible health plan is $7,750.

Catch-up Contribution: Eligible individuals who are 55 or older by the end of the tax year can increase their contribution limit up to $1,000 a year. This extra amount is the catch-up contribution allowed for HSAs.

HSA Contribution Limits 2022

Each year, the IRS sets the maximum contribution amount for HSAs. For calendar year 2022, here’s the detail directly from Internal Revenue Bulletin: 2021-21:

Annual contribution limitation. For calendar year 2022, the annual limitation on deductions under § 223(b)(2)(A) for an individual with self-only coverage under a high deductible health plan is $3,650. For calendar year 2022, the annual limitation on deductions under § 223(b)(2)(B) for an individual with family coverage under a high deductible health plan is $7,300.

Catch-up Contribution: Eligible individuals who are 55 or older by the end of the tax year can increase their contribution limit up to $1,000 a year. This extra amount is the catch-up contribution allowed for HSAs.

Prior Year HSA Contribution Limits

HSA Contribution Limits 2021

Each year, the IRS sets the maximum contribution amount for HSAs. For calendar year 2021, here’s the detail directly from Internal Revenue Bulletin: 2020-32:

Annual contribution limitation. For calendar year 2021, the annual limitation on deductions under § 223(b)(2)(A) for an individual with self-only coverage under a high deductible health plan is $3,600. For calendar year 2021, the annual limitation on deductions under § 223(b)(2)(B) for an individual with family coverage under a high deductible health plan is $7,200.

Catch-up Contribution: Eligible individuals who are 55 or older by the end of the tax year can increase their contribution limit up to $1,000 a year. This extra amount is the catch-up contribution allowed for HSAs.

HSA Contribution Limits 2020

Each year, the IRS sets the maximum contribution amount for HSAs. For calendar year 2020, here’s the detail directly from Internal Revenue Bulletin: 2019-22:

Annual contribution limitation. For calendar year 2021, the annual limitation on deductions under § 223(b)(2)(A) for an individual with self-only coverage under a high deductible health plan is $3,550. For calendar year 2020, the annual limitation on deductions under § 223(b)(2)(B) for an individual with family coverage under a high deductible health plan is $7,100.

Catch-up Contribution: Eligible individuals who are 55 or older by the end of the tax year can increase their contribution limit up to $1,000 a year. This extra amount is the catch-up contribution allowed for HSAs. (Sourced from irs.gov)

Kelley-Long

About the Author

Kelley Long

I believe that the true meaning of financial security is the ability to make decisions without having to worry about money. There are both factual and psychological aspects of this belief and my mission is to help people find that intersection in their own lives according to their personal values and goals.

I hold the CPA/PFS license and am a CFP® professional, but I don’t sell any products or manage any money. When I’m not writing, I’m working one-on-one with people through my coaching business, Financial Bliss with Kelley Long. I’m also a member of the AICPA Consumer Advocate Council and am frequently quoted in the press on financial literacy issues facing Americans.

I am a founding member of the HSA Committee for the Plan Sponsor Council of America, which helps educate employers and employees on HSA best practices while also helping to shape policy around these powerful accounts in Washington.

I love to apply my own money lessons to my writing as well as break down some of the more complicated financial planning techniques into plain English. My goal in life is for all people to feel able to make their own financial decisions with confidence, being fully aware of the pros and cons of the actions they take.

Disclaimer: To make Wealthtender free for our readers, we earn money from advertisers, including financial professionals and firms that pay to be featured. This creates a natural conflict of interest when we favor their promotion over others. Wealthtender is not a client of these financial services providers. Learn how we operate with integrity to earn your trust.