Only 16 percent of employers believe their employees are saving enough money for retirement. While many employers recognize this is an issue, determining the best solution has yielded a variety of different tactics.
One retirement-planning account that’s often overlooked is a health savings account (HSA). Only 7 percent of HSA participants invest their funds, even though an HSA has retirement-planning perks that a 401(k) and IRA don’t have. Keep reading to learn more, or download your free “HSAs and Why You Should Change the Retirement Strategy Story” white paper.
What tax advantages does an HSA share with 401(k) or IRA?
An HSA, 401(k), and IRA can all help employees save money when putting aside funds for retirement. All three accounts provide potential tax savings. And all three are also owned by the individual, meaning that the account stays with the employee whether they remain with their employer or not. That gives the employee peace of mind to lean on these accounts as part of their long-term strategy.
What are the HSA’s perks versus a 401(k) or IRA?
There are two important distinctions related to healthcare costs when comparing an HSA with a 401(k) and IRA:
1) Contributions and withdrawals
- With an HSA, contributions made through payroll deductions are tax-free. Withdrawals to purchase eligible medical expenses are also tax-free.
- With a 401(k), contributions are tax-free, but withdrawals are taxed as any other type of income. Additionally, if they withdraw funds before they turn 59 ½, the funds are subject to a 10 percent early withdrawal penalty.
- With an IRA, there are tax implications for either contributions or withdrawals (depending on the type of IRA).
2) Surprise healthcare costs
- HSA participants who are using the account for retirement planning can tap into funds at any time should a need arise. They are only subject to withdrawal penalties if the funds are spent on ineligible expenses.
- With a 401(k) or IRA, withdrawals prior to age 59 ½ are generally subject to be included in the accountholder’s gross income, plus are subject to a 10 percent penalty.
See the potential HSA retirement savings
Let’s lay out a scenario for someone, who we’ll call Jane Smith. Jane is married with two kids and is preparing for retirement by participating in an HSA, 401(k), and IRA.
- She and her employer contribute $4,000 apiece into each of these accounts: her family HSA, 401(k), and IRA.
- She invests her HSA funds. The return-on-investment for each account is 5 percent annually.
- Her combined federal and state tax rate is 25 percent, and her tax rate at the time she distributes funds is 15 percent.
Watch her funds grow:
That’s a 31 percent increase in healthcare purchasing power with an HSA after 20 years when compared to a 401(k) or IRA! So what happened?
- 401(k) and IRA contributions are subject to FICA taxes (which are 7.65 percent), while HSA contributions are not.
- With a 401(k) or IRA, funds are taxed somewhere, either when they’re contributed or when they’re withdrawn. With an HSA, funds are not taxed when contributed or withdrawn, as long as the purchases are for eligible healthcare expenses.
“Because of the triple-tax advantage nature of an HSA, employees actually make more money than with a 401(k) or IRA,” said Jeff Bakke, chief strategy officer for WEX’s health division. “There are other variables, such as employer matching of HSA or 401(k) funds that employees need to consider. But all things being equal, they’re actually better off putting money in an HSA.”
Would you like to learn more about HSAs and retirement planning? Get your free white paper.
The information in this blog post is for educational purposes only. It is not legal or tax advice. For legal or tax advice, you should consult your own counsel.