HSA vs Maxing out 401K

[JDARNELL]

I am working on preparing some guidance for each of my two sons. Both are or are soon to be recent college grads with stable jobs. Each has 6 months emergency fund saved, no debt, and contribute to a Roth 401K up to the matching contributions from their employers. Their budgeting skills are pretty good and continue to improve. Both have a surplus at the end of each month for now. I am now moving them towards the next step in their financial education.

#1 son will be getting access to an HSA in July and will have some extra funds above what he is currently contributing. So the question is what should he do? (I was never able to utilize a HSA so while I understand the concept I don't understand the conventional thinking)

#2 son will be getting a decent raise the same timeframe as #1 son gets access to HSA but will not have access to a HSA. My thoughts are to work with him on increasing his Roth 401K percentage each pay period towards eventually getting to the Max but also enjoying a little more income each pay period.

Side note: We are working to ring out the return on the emergency fund by laddering the projected timeline need with CDs and or I-Bonds. Roth IRAs are taken care of as gifts and are fully funded each year. No real estate purchases for either of in the next 5 years due to career location change demands and no significant others in the picture at this point however this could change in a few years and at that time another variable for them to consider. I am just trying to help lay the financial habits.

What are your recommendations and thoughts?

JDARNELL

 

[retire48in2018]

Using an HSA for retirement funding, should be after maxing a 401k.

Funding an HSA for expected medical bills, and preparing for longer term medical needs should be considered.

Having funds in the “right” program per purpose helps if future legislation changes and you can no longer repurpose money (using HSA as retirement money).

Here’s how I’d prioritize it

1 - fund HSA to current expected bills (immediate tax relief as this is pre-tax money and used for health is not taxed)

2 - fund retirement to your goal of retirement lifestyle and age (for many that is 10-15% of gross income)

3- max 401k and add HSA somewhat proportionally as a diversification of purpose. HSA has significantly lower annual limits than 401k.

 

[retire48in2018]

401k has additional options for emergency withdrawals (avoiding penalty) and options to use in early retirement (72T). HSA is more limited

401k generally available at 59.5 (earlier with 72T), HSA non-medical - not to 65.

Flexibility makes 401k winner (after initially funding expected bills in HSA).

 

[qwerty3656]

I guess I have the unpopular opinion. I think HSA blows 401k away. Tax free in and out.

 

[RunningBum]

I guess I have the unpopular opinion. I think HSA blows 401k away. Tax free in and out.

No, I'm pretty sure that should be the popular opinion. At worst case you can withdraw from an HSA like a 401K. More likely you'll be able to withdraw tax free.
Get the full match from the employer on a 401K, then contribute to an HSA, then if more can be saved consider whether it'd be better to max out the 401K and invest in a taxable account, buying a tax efficient index fund. The latter would give access to the money before 59 1/2 for a house or early retirement, for example.

 

[FIcontractor]

I agree, HSA is the account I'd fill after getting the 401(k) match since it's tax free in and out if used for medical expense and likely saves on FICA if contributed to through payroll. The "worst" case is that it acts like a traditional IRA (no tax when contributing, taxed when withdrawn) if withdrawn after age 65 without qualified medical expenses.

You might find the Bogleheads recommended investment order Wiki helpful

 

[retire48in2018]

HSA for medical expenses is best, hands down. Can’t be used for monthly premiums.

Outside of medical expenses, HSA can act like a traditional pre-tax 401k after 65. But less flexible prior to 65 (withdrawal without penalty), and no option for Roth conversion.

Early in life -
If I had to choose between a million in HSA or traditional pre-tax 401k, and I wanted to retire early - 401k wins on everything actual except medical expenses.

Choosing a Roth 401k early in life might be best choice - especially if you see income and/or taxes rising, etc.


Later in life -
After 65 - perhaps HSA is preferred to traditional 401k. HSA has 2 advantages to a traditional 401k then - medical expenses tax free, and no RMD.

Of course had you chosen a Roth 401k earlier - RMD is irrelevant.


So - IMO - Roth 401k is winner. but, use HSA for expected current expenses.

 

[RunningBum]

A million is a pretty high target, but I guess if one starts early enough you could hit it if you contributed every year. I would still start with an HSA now, and maybe reduce or stop contributions later if you have been able to contribute for many years and put more in the 401K and/or taxable. I can see your argument for doing a 401K now and HSA later, but you might not have an HSA eligible healthcare policy every year, so I'll stick with my recommendation to do an HSA now. Watch the balance so it doesn't grow beyond what you would probably be able to reimburse yourself for later.

Speaking of high HSA balances, independent of this I found a recent Kitces blog about them. I started a new thread on it: https://www.early-retirement.org/forums/f28/kitces-on-large-hsa-account-late-in-life-117328.html

 

[Figaro]

I've a long term view on savings. The HSA could
be used for Medicare premiums later in life at least (that will be at least $2000/year or by then might be $3-4k. Nothing wrong with fed tax free, state tax free and fica tax free. And all of use have medical expenses eventually in life right?

I'd prefer to invest in Pre-tax instruments, as you save on fed tax, state tax. Clearly there is extra unused space in the retirement accounts for your sons and that's because of the taxes. If they don't pay those taxes up front, they could afford to stash another 2-5k in the 401k. Once you have a big enough pile in Pre-tax 401k and enough in taxable account, say age 40-55, you could stop working. Strategically Roth convert and then start pulling from Roth after five years what you previously converted (at the lowest tax brackets 0%, 10%, 12-15%) Better at that time to move to a state that does not tax retirement income, so you save taxes.

 

[Morgan22]

From you post it sounds like your sons are both graduating college this year.
If they can be claimed this year as your dependents, they cannot contribute to their own HSA. (According to IRS Pub 969.)
So have them wait another year before starting up their own HSA's.

 

[JDARNELL]

From you post it sounds like your sons are both graduating college this year.
If they can be claimed this year as your dependents, they cannot contribute to their own HSA. (According to IRS Pub 969.)
So have them wait another year before starting up their own HSA's.

I lumped them both together. The older one that is not eligible for the HSA has been on his own for a couple of years and is doing well. Just now a larger raise this year, more responsibility, and more breathing room.

Good info on the HSA if the younger one is claimed on our taxes this year. Then this question is still relevant for open season for 1 Jan 2024 year. If we can thread the AOC income limit for the last time we will claim him as we will run the numbers to see what makes sense. I think worse case for his situation is he would just barely bump into the 22% bracket.

However both are squarely in the bracket going forward.

Some good info between this thread and the spin off thread about high balances in an HSA. I think I could make the case to get the HSA up to a starting principle of $15-25K, investing it, and manage it over time as a family comes along as more clarity comes out on health of all involved in that family unit. He will have the choice to change each year to different plans through his employer.

Long term I do suspect the path to maximizing the ROTH 401K is a better option in the next decade. The reality of it is both boys are going to be FI in the next 10-15 years due to inheritance but they don't nor need to know that irrelevant of what their parents do or don't do. I am just trying to develop a road map that they can learn from as they execute or make their own choices to deviate.

 

[nurseratchit]

Does your son’s company also make a contribution to HSA if he selects that? Mine contributed $1600/year to HSA when I selected that option which I was not required to match. Mine has grown large enough over the years that I have the bulk of it invested in Vanguard index funds (offered by BofA HSA) and keep the rest in the cash account to fund our modest medical expenses and potential surprises. There are also many things that qualify that do not require a prescription. HSA is also like an IRA in that I can make contributions up to April 15th on my own, so it’s always an option if I want to reduce MAGI. I am also able to take my HSA with me and continue contributing to it when I leave my employer. It is mostly money I don’t think too much about and it’s a nice safety net for medical curveballs and a bonus IRA after age 65. I did still nearly max out 403b.

Kudos on getting your sons financially educated!

 

[Big Gun]

IMHO, I’d prioritize HSA. 401k/Roth are ultimately marginal tax rate arbitrage decisions.

1. I think young successful people will need to be opportunistic about HSA, and contribute whilst they can - they’ll probably have better health insurance options than HDHP in future years.
2. I didn’t see it mentioned upstream and may have missed it, but qualified health costs can be reimbursed from the HSA at any time.
3. These types (FI) of kids are most likely going to have large retirement account balances, so having a large HSA balance to pay for Medicare and offset IRMAA would be nice.
4. The younger they are when they start an HSA, the longer the investment has to grow. Triple tax benefit.

 

[JDARNELL]

Does your son’s company also make a contribution to HSA if he selects that? Mine contributed $1600/year to HSA when I selected that option which I was not required to match. Mine has grown large enough over the years that I have the bulk of it invested in Vanguard index funds (offered by BofA HSA) and keep the rest in the cash account to fund our modest medical expenses and potential surprises. There are also many things that qualify that do not require a prescription. HSA is also like an IRA in that I can make contributions up to April 15th on my own, so it’s always an option if I want to reduce MAGI. I am also able to take my HSA with me and continue contributing to it when I leave my employer. It is mostly money I don’t think too much about and it’s a nice safety net for medical curveballs and a bonus IRA after age 65. I did still nearly max out 403b.

Kudos on getting your sons financially educated!

Yes $900 is what they put into the HSA for a single person.

 

[Surewhitey]

We do everything. DW's company gives funds to HSA & profit sharing, but we max out everything + catch up on 401ks. I do SEP 401k, catch up and profit deposit of 20%. We live simple and have a good after tax funds to smooth out everything. We're up to $60k-ish on the HSAs.

I'd definitely do the 401k if there is a match, then the HSA, then back to the 401k Roth or traditional depending on the tax rate of your sons.

HSAs are not payroll taxed including Medicare and SS to my understanding ...

 

[kgtest]

Depends. If the HSA has terrible underperforming investment choices then it's not as attractive.

For our family we
1. Max Roth IRAs
2. Max 401k Roth
3. Max 403b
4. Max Family HSA

by way of DCA (with the exception of Roth contributions, we do those straight away on January 1st).

And recently have been doing mega backdoor Roth conversions since we've been in lower tax brackets.

We also put away some in 529s and broker accounts at the end of the year. I might throw an extra payment at my mortgage the last day of the year this year...since that is effectively paying myself 2.75% return guarantied.