Should I use an HSA as a backup for my 401(k)?

HSA vs 401(k)

HSA vs 401(k)

Two of the most popular means of construction savings are 401(k) and health savings accounts, or HSAs. While an HSA is not a traditional retirement account, at least informally, it can give you considerable value as your health care costs can add up in retirement. That helps it serve as a useful backup for more conventional retirement planning tools, like 401(k)s and IRAs. Consider work with a financial advisor as you pursue your retirement goals.

What is a 401(k)?

A 401(k) is a tax-advantaged retirement account. Along with IRAs and Roth IRAs, one 401(k) is one of three main ways the IRS tries to encourage individuals to save for retirement.

The IRS allows you to deduct every dollar you contribute to a qualified 401(k) from your annual income tax. This allows you to pay no taxes on the money you save after retirement. However, you pay taxes on this money when you withdraw it later in life.

The IRS also established a tax deductible annual contribution limit to 401(k). In 2021, you can’t contribute more than $19,500, although this could increase to $20,500 for 2022. For those 50 and older, the IRS allows “offset contributions.” additionally, the total could go up to $6,500 for both 2021 and 2022.

A 401(k) is an employer-run retirement plan. Traditionally, this has meant it is only available to workers who have an employer of some kind. While individuals with their own businesses can set up a 401(k) for themselves, freelancers and former self-employed people cannot set up a traditional 401(k). In recent years, however, this has begun to change, as investment firms have begun to offer 401(k) group plans that individuals can sign up for.

Generally, employers will structure their 401(k) plans like a traditional portfolio, although investments are limited. In fact, they often include target-duration funds, which are investment groups that vary based on how close you are to your retirement date.

These portfolios are managed directly by the employer or by a financial management company of the employer’s choice. Some employers contribute to employee 401(k) plans also. This is not necessary, but employers also get a tax break if they contribute to an employee’s retirement account.

What is a Health Savings Account (HSA)?

HSA vs 401(k)

HSA vs 401(k)

One health savings account or HSA is a type of tax-advantaged savings account that was originally built to help people set aside money for medical expenses. This is especially relevant as people save for retirement, as medical costs tend to increase with age.

You can only apply for an HSA if you are enrolled in a high-deductible plan. This means that your health insurance only begins to pay for your medical expenses after you have paid a substantial portion of your medical bills out-of-pocket. The IRS defines high-deductible plans as $1,400 for individuals and $2,800 for families. If your health insurance coverage changes, you can keep your existing HSA but don’t deduct any contributions you made to it while on the high deductible plan.

The HSA is very similar in structure to a 401(k), and in fact, many employers offer these plans to their employees. Most accounts are set up as a portfolio with a primary mix of mutual funds. Although some HSA accounts offer a simple savings account with a modest interest rate and are built solely to help people save money rather than help them increase it.

You are free to contribute to this account at will, although if you have an employer-run HSA, they may allow you to contribute a fixed amount from your paycheck. Some employers will also contribute to an employee’s HSA, again similar to a 401(k), but this is relatively rare.

Unlike a 401(k), you can open an HSA yourself if your employer doesn’t offer one. (Again, readers should note that finding 401(k) plans is becoming easier for individuals, but this is a relatively new development.)

Like a 401(k), you can deduct all the money you put into your HSA account from your account. federal income tax, the money you save is exempt from federal taxes on medical expenses. Just like a 401(k), the IRS sets an annual contribution limit. In 2021, you can contribute up to $3,600 for individuals and $7,200 for families. For 2022, these limits increase to $3,650 for individuals and $7,300 for families. Through these points, you can still contribute funds to most HSA accounts, but you cannot deduct additional contributions.

Use an HSA as a Backup for your 401(k)

Health savings accounts have three basic rules for withdrawals:

  • Medical costs: If you withdraw money from an HSA to pay for medical expenses, you pay no tax on your withdrawal. In this case, you really have completely tax free money to help pay for your medical expenses. While you must have a high-deductible insurance plan to contribute to an HSA, you can withdraw this amount even if you have a better insurance plan later in life.

  • Non-medical expenses, before retirement: The IRS charges a hefty 20% penalty fee if you’re withdrawing money from an HSA to pay for non-medical expenses and you’re under age 65. In that case, you must pay both income tax on the amount you withdraw and the penalty.

  • Non-medical expenses, after retirement: If you withdraw money from an HSA after age 65 for non-medical expenses, you don’t have to pay any penalties. However, you must pay regular income tax on the amount you withdraw.

This is the last point that allows HSA plans to act as a form of supplemental retirement plan for some people. During your working life, the tax rules for contributing to an HSA are the same as a 401(k) but with a smaller annual maximum. Once you’ve passed retirement age, the rules for withdrawing from an HSA are the same as withdrawing from a 401(k). Therefore, if you are eligible to open an HSA during your working years, you can effectively use the account as a second retirement account.

For those who want to increase their retirement savings this can be a great way to earn a little more money from tax-advantaged programs. This is especially useful for young workers. People in their 20s can often get away with high-deductible health plans (as long as they’re absolutely certain they can afford that deductible in the event of a medical emergency). economic). For this group, you should open a health savings account and keep the money there while young and healthy. Then, as you grow and move into a more comprehensive plan in your 30s, you can simply leave that HSA alone to accumulate value from decade to decade.

bottom line

A health savings account is a tax-advantaged form of investment that allows people with high-deductible health insurance to set aside money without paying taxes on it. If you don’t need this money in the end to pay for your health care, when you reach retirement age it can also serve as a good addition to your retirement savings.

Tips on retirement planning

HSA vs 401(k)

HSA vs 401(k)

  • Planning for retirement is stressful. Fortunately, Financial Advisor can offer many options to save your working years. Finding a qualified financial advisor is not difficult. SmartAsset’s free tool connects you with up to three financial advisors serving in your area, and you can interview the right advisors for you for free to decide which one is right for you. If you are ready to find an advisor who can help you achieve your financial goals, start right now.

  • our free retirement calculator will help you determine how much you need to save for retirement. Planning for this in advance can be extremely helpful in the long run.

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