Studies show as many as one in five people regret their choices made during the open enrollment period, and it's fast approaching.
For millions of American workers, Open Enrollment starts November 1, when decisions will be made to choose healthcare and retirement plan benefits for 2023.
While the 401(k) plan remains one of the most popular employee benefits to save for retirement, financial experts say your Health Savings Account (HSA) could pack an even more powerful punch with tax advantages unknown to most people.
“When it comes to comparing the 401(k) to the HSA, ideally I'd want clients to contribute enough to their 401(k), so they receive the full company match if that's available to them,” said Kelly Klingaman, Certified Financial Planner and founder of Kelly Klingaman Financial Planning.
“Apart from that, if they have the ability to save more, we aim to max out their annual contribution limit into the HSA next before adding any more money into their 401(k).”
For people with very low healthcare costs, putting the maximum into HSA-eligible healthcare plans is almost a no-brainer. This is especially true when their employer contributes to their account to help offset the deductible.
If you don't spend that money, it's yours to keep, and it rolls over year after year for when you do eventually need it, perhaps in retirement to help pay Medicare Part B or long-term care insurance premiums.
Max It Out?
Even if you have higher healthcare costs, HSAs can still be a great deal. Many workers continue to contribute to their high-deductible plan after they reach their out-of-pocket maximum for their healthcare plan just to max out their HSA contribution.
Those looking to reduce taxable income appreciate the ability to exclude annual contributions from taxes up to the limitations set by the Internal Revenue Service (IRS). Contribution limits for family coverage were $7,200 in 2021, $7,300 in 2022, and $7,750 in 2023. Note: add another $1,000 to these figures if aged 55 or older.
It's clear the optimal strategy is to max out your HSA before funding your 401(k) or another retirement account beyond their employer's match. The HSA rules make it a much better deal.
The funds can carry over indefinitely with the triple tax-free benefit of funds going in tax-free, growing tax-free, and coming out tax-free for qualified medical expenses.
Healthcare costs are one of the biggest uncertainties while working and in retirement. A large medical expense for people without adequate emergency savings often leads to 401(k) loans or, even worse, early withdrawals, incurring additional tax and early withdrawal penalties to add to their financial woes.
Saving to an HSA not only means funds available when such expenses come up, but participants save on taxes rather than cause additional tax burdens.
“As far as tax-advantaged savings vehicles are concerned, HSAs are at the top of the list,” said Ryan Firth, founder, and president of Mercer Street Personal Financial Services. “They're like a tax-deferred account combined with a tax-free Roth account.”
“Company matches on a qualified plan like a 401(k) would be about the only savings play that would trump an HSA. However, some employers will contribute to an employee's HSA as a form of tax-free compensation,” Firth added.
The same consideration goes for healthcare costs in retirement. Again, having tax-free funds available to pay those costs rather than requiring a taxable 401(k) or IRA distribution can make a huge difference to retirees with limited funds.
Say you remain robustly healthy in your later years with little need for healthcare-specific savings. In that case, HSA funds are also accessible for distribution for any purpose without penalty once the owner reaches age 65, which many people are unaware of.
Non-qualified withdrawals are taxable, but so are withdrawals from pre-tax retirement accounts, making the HSA a fantastic alternative to retirement savings.
Optimize Savings Options
To summarize, when prioritizing long-term savings while enrolled in HSA-eligible healthcare plans, experts suggest the order of dollars goes as follows:
First, contribute enough to any workplace retirement plan to earn your maximum match. Next, max out your HSA. And finally, go back and fund other retirement savings like a Roth IRA (if you're eligible) or your workplace plan.
Payroll vs. Lump Sum
Remember, you can make HSA contributions via payroll deduction if your plan is through your employer. You can change contributions at any time. You can also make contributions via lump sum through your HSA provider, although funds deposited that way do not save you the 7.65% (Federal Insurance Contributions Act) FICA tax as they would when depositing via payroll.
For those unsure of the best way to invest in their HSA for long-term growth, hiring a nearby financial advisor familiar with local employers and their benefits can instill confidence in the decision-making process. Most advisors suggest the HSA ranks as one of the most powerful wealth-building tools available to people who can afford to contribute the maximum amount and avoid spending down their accounts on small expenses.
The bottom line is that when deciding between HSA healthcare plans and other plans this enrollment season, there's more to consider than just current healthcare costs, and it often makes sense to max out your HSA. In summary, HSAs can be an important part of your long-term retirement savings and greatly impact your lifetime income tax bill.
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