3 Reasons Why Your HSA Should Be The First Retirement Account You Fund

For many people, using a 401(k) as their primary retirement savings vehicle has been baked into their retirement planning framework. However, just because it’s the norm doesn’t mean it’s right. Enter the HSA.

While most people think of HSAs as medical-only savings accounts, the truth is they’re the best way to save for retirement, hands-down. Even if you don’t think you’ll have high medical costs in retirement, your HSA should still be the first retirement account you contribute to; here are 3 reasons why.

  • 1. HSAs essentially become 401(k) plans once you turn 65

If you withdraw funds from your 401(k) before the age of 59½, those funds are subject to income taxes, as well as an additional 10% tax penalty. HSAs have a similar setup; if you use HSA funds for non-medical expenses before you turn 65, you’ll have to pay income taxes and an additional 20% tax penalty on those funds.

However, once you turn 65, that 20% tax penalty is removed, and non-medical HSA withdrawals are only subject to income taxes. From a tax perspective, your HSA is treated exactly the same as a traditional 401(k) or IRA, which means you should never be afraid of putting too much into your HSA. If you end up pulling out funds for non-medical costs in retirement, it’s just like withdrawing money from your 401(k).

  • 2. HSA withdrawals for medical expenses are always tax-free

Traditional 401(k) plans aren’t taxed upon contribution and contributed funds grow tax-deferred, giving them two tax advantages. However, you pay taxes on your 401(k) funds once they’re withdrawn in retirement. HSAs have all the tax benefits for contributions and earnings, but in addition, funds withdrawn for qualified medical expenses are tax-free. This giving HSAs an unparalleled triple tax advantage on healthcare costs.

Those tax savings become extremely valuable when you look at the cost of healthcare expenses in retirement. According to a recent Healthview study, non-Medicare-covered retirement medical expenses can be up to $387,000 for a couple retiring at age 65. If your only retirement vehicle is a 401(k), you could end up paying up to $120,000 more in taxes to cover those costs. However, if you have a mature investment HSA, you can pay for these expenses tax-free and save your 401(k) funds for other costs.

  • 3. Contributing to an HSA can get you free money back in your pocket now

When you put money into a 401(k), those contributions are tax-free at the federal and state* levels. However, you still have to pay FICA taxes on those contributions, which add up to 7.65%. But when you contribute to your HSA via payroll withholding through your employer’s Section 125 plan, you avoid FICA taxes on those contributions (and so does your employer). That’s an extra 7.65% back every time you make an HSA contribution!

Here’s a real-life example: If you contributed $500 each month to your 401(k), you’d have $6,000 in the account by the end of the year. If you contributed $500 each month to your HSA via pre-tax payroll withholding, you’d have the same $6,000 in your account at year’s end. However, since you didn’t pay FICA taxes on those HSA contributions, you give yourself an extra $460 bonus that year. And the best part is, you don’t have to make any extra effort to get that free money; all you’re doing is optimizing your retirement contributions!

Breaking out of a 401(k)-centered retirement framework and not following the norm with your retirement planning may not be easy, but it’s certainly worth it. By prioritizing your HSA as your first retirement savings option, you put money back in your pocket now, as well as put yourself in a better place for when you do stop working.

If you don’t have an HSA yet, we’d love to help you invest in a financially secure retirement; sign up for an HSA here. If you already have an HSA but would like a more investment-minded partner, our carefully-curated lineup of high-quality, low-cost funds and $0 investing threshold make us a perfect fit. See our fund lineup here.

We recommend consulting with a financial professional before implementing any changes to your retirement contribution plan.

* HSA contributions and earnings are tax-free at the federal level and tax-free at the state level in almost all states. Learn more here.