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Why an HSA is at least 17% better than a 401(k)


Soon you will be contributing more money to your health savings account.

Last week, the IRS announced the largest increase in the maximum contribution to popular savings vehicles.

In 2024, the maximum HSA contribution will be $4,150 for an individual and $8,300 for a family, up from $3,850 and $7,750, respectively, in 2023. Add an extra $1,000 you can put away if you’re over 55 , and the maximum contribution is $5,150 for individuals and $10,300 for couples.

That’s a big deal for long-term savers. That’s because, when used to its full potential, an HSA can be a more powerful retirement savings account than many traditional vehicles, such as 401(k)s and individual retirement accounts. .

Consider a calculation from Blake Hilgemann, a financial coach and author of the “Pathway to Financial Independence” newsletter: “Every dollar in an HSA is worth at least 17.65% more than a dollar in a 401(k),” he wrote in a recent tweet.

Hilgemann’s arithmetic works because of the unique tax advantages of the HSA. Unlike other types of tax-advantaged retirement accounts, HSA contributions and investment earnings are never taxed, as long as you follow the rules for withdrawing from the account.

That means you avoid paying income tax on your withdrawals, which, at current rates, is at least 10%. And because HSA funds aren’t subject to the 7.65% employee tax credit, you’ll come out at least 17.65% ahead if you save one, Hilgemann says.

That’s especially powerful for people who are, or expect to eventually become, high earners. “If you’re in a high tax bracket, the HSA is a complete cheat code for you,” Hilgemann told CNBC Make It.

Here’s a closer look at why HSAs can be more powerful than other retirement accounts.

The tax advantage of HSA

When you invest in a traditional 401(k) or IRA, you get an immediate tax advantage: The money you invest in these accounts can be deducted from your taxable income in the year you make the contribution.

Instead of the upfront tax break, you owe income tax on any money you withdraw from these retirement accounts. And if you take the money out before age 59½, you owe taxes and a 10% penalty.

But investing in an HSA has a triple tax advantage. Like a 401(k), contributions to these accounts can be deducted from your taxable income. While in the account, your investments grow tax-free. Then, when you withdraw the funds, you owe no taxes as long as you put the money toward qualified medical expenses.

It’s easy to see why Hilgemann advocates that you can save “at least” 17.65% in an HSA, because if you’re in a higher tax bracket, you can save even more by avoiding income taxes. . Currently, single filers earning more than $578,125 pay a top marginal federal income tax rate of 37%.

How to save for retirement with an HSA

To contribute to an HSA, you must be enrolled in a high deductible savings plan, a type of health insurance with a deductible (the amount you must pay out of pocket before your insurer begins to cover expenses) of at least $1,500 for self alone. coverage and $3,000 for family coverage.

Like the more common flexible spending account, you can make automatic, pre-tax contributions from your paycheck to help fund health care costs. But unlike an FSA, HSAs don’t come with a “use it or lose it” provision.

Instead, the money is held in an account that belongs to you. And once it’s in your account, you can invest it however you want – in stocks, bonds, mutual funds, exchange-traded funds and other types of securities. The longer you stay invested, the longer your investments should generate compounding returns over time.

“The most important aspect of an HSA, even more important than the triple tax savings, is the flexibility to use it at different stages of a person’s life,” said Kevin Robertson, senior vice president and chief revenue officer of HSA Bank. “Every American, at some point in their lives, will be a spender or a saver for health care needs.”

To use an HSA as a retirement savings vehicle in the same way you would a 401(k) or an IRA, however, you must be able to comfortably cover the costs of care. health out of pocket – at least. until you hit your deductible each year.

If you have chronically high health care costs, it can get expensive fast, and a plan with a lower deductible may be more suitable for you.

If you can cover your expenses in the short term, however, you can build up strong tax-free retirement savings.

Remember, the money is tax-free only if you use it for medical expenses. But if you are strategic about it, that should be easy. For one thing, you likely have medical bills to pay in retirement. In 2022, the average 65-year-old retired couple will need nearly $315,000 to cover health care costs in retirement, according to Fidelity.

Additionally, your medical expenses do not have to be concurrent to count when you withdraw the money. During the years you cover your expenses out of pocket, be sure to digitally save your receipts.

“Those expenses don’t really get worse. You can have 20 years of expenses, and then in retirement you want to take a vacation,” Jeremy Finger, a certified financial planner and founder of Riverbend Wealth Management, told CNBC Make It. “You can withdraw $15,000 from your HSA and use the receipts to make your withdrawal tax-free.”

In other words, as long as you have receipts for medical expenses, you can pay yourself and use the money for whatever you want. It is not a bureaucratic process where you have to submit expenses to get the money.

“It’s all self-evident,” Robertson said. “It’s between you and the IRS as long as you have the receipts to back up your claims if you get audited.”

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