Q: I want to increase my savings rate in 2020 and I’m trying to decide between increasing my 401(k) contributions or starting to fund my HSA. Which is the best option?
First of all, you should contribute enough to your 401(k) to take full advantage of your employer’s matching contributions, so if you’re currently not putting in enough to get the full match, that’s where your extra money should be going.
Assuming you’re doing that, and that you’re eligible to contribute to a health savings account (HSA), there are a few good reasons you might want to divert some of your paycheck into one.
For one thing, you can use the money before you retire. It’s designed to help cover healthcare costs, no matter when they occur. Any HSA funds used for qualified medical expenses get a double tax benefit that’s unlike any retirement account — not only are contributions tax-deductible, but any qualified withdrawals are as well. Money in your HSA can be invested while it’s in the account, so this can be a big benefit.
Unused HSA funds carry over from year to year, so these accounts can really build up over time and can be a great way to save for healthcare expenses in your retirement. Fidelity estimates that the average 65-year-old couple can expect to pay $285,000 in out-of-pocket healthcare costs in retirement, and being able to withdraw tax-free for this purpose can certainly help lessen the sting.
Finally, you can use HSA funds for any reason after you turn 65, although any non-healthcare-related withdrawals will be considered taxable income.
Other than the lower penalty-free withdrawal age of 59 1/2, there aren’t too many advantages to putting extra money into your 401(k) if you’re also eligible for an HSA. It’s wise to learn a bit more about how HSAs work, but the bottom line is that if you’re eligible and have maxed out your employer’s matching program, contributing to an HSA is certainly worth considering.
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