Watch Out, 401(k)s: HSAs Are the New Retirement Sheriff in Town

In 2021, the Employee Benefit Research Institute (EBRI) reported that 56% of 401(k) participants lowered their 401(k) contributions in the first year they contributed to their health savings account (HSA). Are these savers savvy retirement planners, or are they making a critical retirement mistake?

Either answer could be true depending on the situation. However, the HSA does have a compelling set of benefits. Here are four reasons why maxing out your HSA could be your smartest retirement move, even if it means lowering your 401(k) contribution.

1. Get a triple tax benefit

The 401(k) has two main tax advantages. One, you fund the accounts with pre-tax money, which reduces your taxable income. And two, your realized gains, interest, and dividends in the 401(k) are tax-deferred. Rather than paying out taxes each year on those earnings, you wait and pay taxes on qualified retirement distributions.

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The HSA has these two tax perks, plus one more. With an HSA, any withdrawals you use to cover qualified medical expenses are tax-free. No other account has that feature.

Even better, you can take tax-free medical withdrawals any time you have sufficient funds in the account. You don’t have to wait until you’re retired.

2. Lower one of your largest expenses

The HSA’s triple tax benefit addresses what could be your biggest, scariest living expenses in retirement. In 2021, the financial company Fidelity estimated that the average couple retiring in that year would need $300,000 to cover out-of-pocket medical expenses in retirement. Fidelity has also advised seniors to expect their medical expenses to consume 15% of their annual income.

Using untaxed money to cover your healthcare bills creates huge savings over time. Say you currently pay out 22% of your taxable income to the feds. With an HSA, you can skip that tax dilution of your money to the extent you have medical costs.

3. Take non-medical distributions after age 65

Once you reach age 65, you can take non-medical withdrawals without penalty from your HSA. These are taxable, just like a 401(k) distribution.

Thanks to this feature, it’s tough to overfund your HSA. If it turns out you don’t need the money for out-of-pocket medical expenses, your HSA can function as a backup to your 401(k). You’d take taxable withdrawals and use the funds to cover your living expenses.

4. Get paid to contribute

Many employers provide matching HSA contributions. These are less generous than the 401(k) match — but it’s still free money. As with your 401(k) match, it’s smart to take all the contributions your employer is willing to provide.

And if you’re wondering how to prioritize 401(k) and HSA matching, here’s one school of thought: Contribute enough to your 401(k) to get your full match. Then, max out your HSA contributions. If you still have room to contribute after that, increase your 401(k) contributions — up to the annual IRS limit if you can.

Team up your 401(k) and HSA

Your HSA and your 401(k) both serve the same broader purpose — to help you prepare financially for retirement. It’s a mistake to view them as competitive offerings, however. Your HSA and 401(k) complement each other, like any great sheriff-and-deputy team. Use them both, side-by-side, to build the retirement you want.

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