HSA vs. 401(k): Which is Better?

First, let’s look at each.

Then, let’s show you how we walk people through the decision-making process.

HSA: Funds deposited into an HSA have a triple-tax advantage. First, the funds are taken from your paycheck, which means that contributions lower your taxable income. Second, your HSA investments grow without being taxed, and finally, any money taken out for eligible medical costs is not taxed.

Keep in mind that your employer must offer a high-deductible insurance plan for you to participate in a company-sponsored HSA. Most companies (about 75%) also contribute to an employee’s HSA, which can be an added incentive designed to encourage participation. Nonetheless, it’s important to remember that while a high-deductive plan can reduce your monthly premium, it can also increase your out-of-pocket costs.¹

401(k): Your contributions to a 401(k) are also taken out of your paycheck, and any earnings on investments escape taxes. Taxes are due when the account holder withdraws the funds, which is typically done in retirement when the person may be in a lower tax bracket.

Approximately 70% of all employees now have access to 401(k)-style retirement plans, and the Plan Sponsor Council of America says 98% of companies offered some type of matching funds.^2,3

Pros and Cons⁴

Both Have Limits: Both HSAs and 401(k)s have contribution limits.

Both Have Rules: HSAs are not subject to required minimum distributions (RMDs). But with a 401(k), after reaching age 73, you must begin RMDs that are taxed as ordinary income. If a withdrawal is taken before age 59½, a 10% federal income tax penalty may apply.

Borrowing? Borrowing is permitted for a 401(k) plan. Also, a first-time home buyer can tap the funds and withdraw up to $10,000 without penalty. You are not allowed to borrow from your HSA, but after age 65, the medical restriction is dropped, and you can use your HSA money for any purpose.

How to decide?

As with many things in personal finance, this is often not an all or nothing decision for most people.

If your company offers 401(k) matching funds, we will take that into consideration as we evaluate your investment choices.

Meanwhile, your overall health will play a role in determining whether an HSA is a good fit for you. An HSA can be a clever way to set aside money for healthcare costs in retirement since the funds can be used to pay for Medicare premiums.

There are a lot of moving parts, but these are great conversations to have. We enjoy showing you the benefits and limitations of both, and guiding you to the decision that works best for you.