HSAs: The Best Way To Save For Retirement

HSAs are the unquestioned top choice for paying for current medical expenses or saving for future healthcare costs. Unfortunately, they’re often pigeonholed as medical-only savings accounts and typically take a back seat to 401(k)s and IRAs in the general retirement savings discussion. However, once you fully understand HSAs’ tax benefits, it’s hard to argue that they aren’t the best way to save for retirement, period. Let’s dive in.

Background: Traditional Plans, Roths, & HSAs

401(k)s and IRAs are divided into two categories: traditional and Roth. With traditional plans, your contributions are tax-free at the federal level (and the state level, in some states). Your contributions then grow tax-free over time. When you withdraw the funds after you turn 59½, however, you do have to pay federal income taxes on those withdrawals (and state income taxes, depending on your state).

With Roth plans, it’s the opposite. Your contributions are subject to federal income tax (and possibly state income tax), but your contributions grow tax-free like a traditional plan. However, your withdrawals after 59½ are tax-free at the federal level (state tax depends on your state). Early withdrawals from both traditional and Roth 401(k)s and IRAs are subject to a 10% tax penalty.

With an HSA, your contributions aren’t taxed at the federal and state level (in most states), and earnings and interest grow tax-free (in most states). In addition, your withdrawals are also tax-free when used for a qualified medical expense, although withdrawals for non-qualified expenses face applicable income taxes and an additional 20% penalty. However, the 20% penalty goes away after you turn 65, so non-medical withdrawals after 65 are treated exactly the same as withdrawals from a traditional 401(k) or IRA.

Since non-Medicare-covered medical expenses can be up to $387,000 for a couple retiring at age 65, more and more people are talking about HSAs’ value in retirement. Those conversations typically paint HSAs as solely medical savings accounts, though. But as we’ll see below, HSAs’ unique ability to skip FICA taxes sets them apart from 401(k)s and IRAs and makes them the top choice for any type of retirement saving.

HSAs’ Secret FICA Savings

The FICA tax is comprised of Social Security and Medicare taxes, and this combined tax is typically 15.3% (the Social Security tax is 12.4% on all wages up to $132,900, and the Medicare tax is 2.9% on all wages, with an additional 0.9% for employees with wages higher than $200,000). Employers and employees split the tax, so each typically pays 7.65%.

When you contribute to a 401(k) or IRA, those contributions are subject to FICA taxes, regardless of whether you have a traditional or Roth plan. With an HSA, though, you never have to pay FICA taxes on contributions done via payroll withholding through your employer’s Section 125 plan, and neither does your employer. For each HSA contribution, that’s an extra 7.65% back for you and for your employer!

Let’s break that down. If you contributed $500 each month to a 401(k), you’d have $6,000 in the account by the end of the year. If you contributed $500 each month to an HSA via 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’d have an extra $460 in take-home pay by the end of the year. You can then contribute that extra $460 of annual FICA savings into your HSA; over 40 years, those FICA savings alone could grow to over $75,000*!

Prioritizing Your Retirement Savings

Knowing HSAs’ superior tax benefits, you may want to consider structuring your retirement contributions to increase your tax savings:

1. Contribute enough to your HSA and 401(k) to get any employer matches. Always take advantage of any match your employer offers. There’s no easier way to get free money.
2. Max out your HSA via payroll withholding. In 2021, the HSA contribution limits are $3,600 for individuals under self-only insurance coverage and $7,200 for individuals under family coverage. By contributing via payroll withholding, you’re saving FICA taxes and putting money back in your paycheck. In fact, you could even calculate how much you’re getting back in FICA savings and put that extra money back into your HSA.
3. If you have money remaining after maxing out your HSA, put it in your 401(k). Although your contributions will be subject to FICA taxes, you’re still getting significant tax savings.

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

This type of savings plan requires a shift in thinking. It means reframing HSAs as general retirement vehicles rather than medical-only savings accounts. It means changing the H in HSA to mean “holistic,” not “health,” and thinking of it alongside 401(k)s and IRAs. And it means committing to keep HSA contributions in your account and investing them long-term rather than pulling them off for current medical costs.

It might not always be easy, but it’s worth it. Because when you’re talking about retirement, every dollar saved counts, and HSAs are the hands-down best way to keep your money out of Uncle Sam’s pocket and growing for you. Ready to get started? Open up an account today.

*This calculation assumes a 6% market rate.