What's the Difference Between an HSA and a 401k?

A 401k is the most common retirement account. Considering the tax-free growth and ease of setting and forgetting it, that makes sense. A Health Savings Account (HSA) on the other hand also brings tax advantages, but arguably more flexibility. But the good news? You can have both at the same time! Let’s dig into more of the differences so you can learn how to use them both to better plan for retirement.

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How is an HSA different from a 401k?

1. HSAs are portable

First of all, the ownership of these two accounts differs. Most of the responsibility of a 401k falls on the employer to facilitate and ensure compliance since the funds going into the account are taken out of paychecks. While your 401k stays with you wherever you go, it typically hinges on your employment status. When it comes to the HSA, it is an individual’s choice to go with an HSA-eligible high-deductible health plan and an individual’s responsibility to be compliant with HSA guidelines. Although healthcare often also hinges on employment status, healthcare can be purchased privately or via health insurance markets. Additionally, HSAs have more prerequisites to meet before one can own the account. So if you like having the most control over your accounts, you’ll love an HSA!

2. HSAs have more tax advantages

The HSA is a triple-tax advantaged account, whereas the 401k is double-tax advantaged. How does that break down? With both, all of your gains are tax-free, and you can contribute pre-tax dollars to the account. What taxes are taken out of those pre-tax contributions does vary, however. Contributions to your 401k are still subject to Social Security and Medicare taxes, while contributions to your HSA are not. The other major difference and third tax advantage of the HSA is that you can spend your HSA funds tax-free on qualified expenses at any time. 

3. 401ks have higher contribution limits

The second key difference between the HSA and the 401k is how much you're able to contribute to each account annually. For 2021, HSA contribution limits are $3,600 for an individual and $7,200 for families. 401(k) limits are $19,500 for individuals. These are individually-owned and not tied to a health care plan, so there's no family limit. 

4. You can tap into HSA funds whenever you need

Another key difference is how and when you can use the funds in each of these accounts. HSA funds are always available to use without penalty as long as they're used on qualified medical expenses. Your HSA turns into a traditional retirement account when you turn 65, after which you can use it on anything—including that dream vacation you've been waiting for! 401(k) funds, however, don't become entirely available until you're 59 ½ years old. If you tap into them anytime before then, you'll owe both federal income tax and a 10% penalty on the amount you withdrew.

5. 401ks have required minimum distributions (RMDs)

Unfortunately, you're not going to get to watch your 401(k) grow tax-free forever. Once you reach 72 years old, you will have to take out a required minimum distribution (RMD) on some of your retirement funds to be taxed. 

This rule does not apply to HSAs, however, so you can let your HSA grow for as long as you'd like (although we'd hope you spend it on things you need, like that retirement vacation).

Using an HSA and a 401k together 

We're not ending this without a little strategy talk! First off, most experts would recommend maxing out HSA contributions before maxing out 401(k) contributions because of the tax advantages that come with the HSA. There's no minimum age for HSA fund distributions, so when you need it to spend money on health care, it's got your back. Now, what would it look like if you played your cards right with your HSA and 401(k)? We're glad you asked!

Let's say you're 33 years old now and have managed to set aside an average of $10,000/year in your 401(k). Your company contributes 50% of your contributions up to 6% of your salary. You'd like to retire by the time you're 66 years old, if not sooner. Factoring in the average annual rate of return on savings (7%)... by the time you retire, you'll have $1,766,775 in your 401K.

Applying the same logic to your HSA, and assuming you maxed out the annual contribution limit for a family (~$7,200) every year, you could have an additional $1,066,047. Which brings your retirement grand total to $2,832,822. Yep. Two whole commas.

So, all in all, if you're able to utilize both your HSA and 401(k) to their full potential, their differences will be hugely beneficial.