HSA vs 401k vs other - low tax bracket

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inbox788
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HSA vs 401k vs other - low tax bracket

Postby inbox788 » Thu Mar 16, 2017 4:34 pm

A young healthy relative asked me whether they should add $1000-2000 savings to their HSA or 401k or is there another better option. He's in the 15% tax bracket. There is no matching in the 401k and the HSA requires $2000 in cash before allowing investments (which I'll assume there's at least one decent choice). He put in over $1000 cash last year, so will be able to invest soon if he keeps adding. He has 3-6 months expenses in emergency fund, so HSA is on top of that. Thanks for your thoughts and any suggestions.

TradingPlaces wrote:In situation like yours, if you have a pot of money available for savings, then you allocate the incremental dollar like this:

1. Keep adding to 401K until you have fully utilized the match,
2. Next, start and keep adding to HSA, until HSA fully funded,
3. Then, continue adding to 401K until Federal Maximum.

If you are relatively healthy, HSA is unlikely to be a better deal than 401K. Nevertheless, when you are older and more asset rich, you might like to spend some money on certain things that you would not, e.g., get more than one pair of glasses, get prescription sun-glasses, get better dental care, e.g., implant instead of denture or bridge.

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ved
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Re: HSA vs 401k vs other - low tax bracket

Postby ved » Thu Mar 16, 2017 4:54 pm

If the person is just starting out in his/her career, meaning that their tax bracket could increase in future, then this might be a good time to start or fund their Roth IRA.
S/he can contribute upto $5500 per year to a traditional or a Roth IRA. Being in the low tax bracket now means that they can contribute to a Roth IRA at a relatively low cost to have a nice pot tax-free when s/he retires.

Easy Rhino
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Re: HSA vs 401k vs other - low tax bracket

Postby Easy Rhino » Thu Mar 16, 2017 7:16 pm

I agree the Roth IRA might be a good idea if there's a reasonable chance their tax bracket will go up.

However, then the HSA might be better on a pure tax basis, because it will also skip FICA taxes and will be tax free upon withdrawal as long as it's used for medical expenses, so reaping the most total tax benefit. It's just that investing in HSAs is generally more of a pain with often higher expenses.

kmok
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Re: HSA vs 401k vs other - low tax bracket

Postby kmok » Thu Mar 16, 2017 7:30 pm

Major advantage of HSA compared to traditional IRA and Roth IRA:
Roth IRA is tax free on distribution. Traditional IRA contribution is tax deductible. HSA contribution is tax deductible AND tax free on distribution on qualified medical expenses.
HSA contribution may not even subject to payroll tax on most plans
HSA participants can take advantage by paying for medical costs out of pocket and retaining receipts but allowing their accounts to grow tax-free.
Money can then be withdrawn years later for any reason up to the value of the receipts.
Generally need to be in High Deductible healthcare plans to contribute to HSA

Major disadvantage of HSA compared to traditional IRA and Roth IRA:
Administrative and investment expenses are higher than the best IRA account providers
Some states do not provide state tax exemption.

inbox788
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Re: HSA vs 401k vs other - low tax bracket

Postby inbox788 » Thu Mar 16, 2017 7:43 pm

I've already suggested using Roth for Emergency Fund.

https://www.bogleheads.org/wiki/Roth_IR ... gency_fund

The pickle is whether the marginal dollar is best used adding more to Roth, 401k or HSA. He's likely to be in same low tax bracket or higher in retirement. The HSA has a high cash requirement, so investments returns will be diluted by cash holdings. I guess that's not a bad thing, because if you held your emergency fund in Roth account, it should be in safe holdings as well.

He can spend down the HSA in a few years and contribute funds to Roth or 401k. Or he can just add to HSA to get both benefits on future medical expenses. Besides the double tax benefit from the HSA, there's a chance he would spend it before retirement. For a medical emergency, the HSA is the best account followed by Roth contributions withdrawals. Looks like there is some different consideration for IRA vs 401k. In general emergencies, the Roth is the most flexible.

https://www.irs.gov/retirement-plans/pl ... tributions

So, I think I've come to the conclusion that in a higher tax bracket it's HSA vs. 401k, but in a lower tax bracket it's HSA vs Roth. But that still leaves the decision about which to fill first, and I'm starting to lean a little towards the HSA at first, maybe to around $5k? Or maybe 1X, 2X or 3X deductible? Then move on to Roth?

deltaneutral83
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Re: HSA vs 401k vs other - low tax bracket

Postby deltaneutral83 » Thu Mar 16, 2017 9:40 pm

HSA is the answer. HSA's are payroll tax exempt which nothing else is. 7.65% of $3,400 is $260 bucks per year individually.

teen persuasion
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Re: HSA vs 401k vs other - low tax bracket

Postby teen persuasion » Thu Mar 16, 2017 9:41 pm

Need more details.

Will he be eligible for the Retirement Saver's credit? 401k or IRA before HSA, at least to $2k, or $2k each if MFJ.

Eligible for EITC, or could be if lowered AGI? HSA thru payroll deductions and/or t401k, not tIRA or Roth.

Filing FAFSA for dependents? HSA thru payroll deductions, possibly additional t401k or tIRA to lower AGI to meet Simplified Needs Test, or meet auto EFC = 0.

inbox788
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Re: HSA vs 401k vs other - low tax bracket

Postby inbox788 » Fri Mar 17, 2017 3:04 pm

deltaneutral83 wrote:HSA is the answer. HSA's are payroll tax exempt which nothing else is. 7.65% of $3,400 is $260 bucks per year individually.

Yes, that helps tilt towards HSA over Roth to begin. Thanks!

teen persuasion wrote:Need more details.

Will he be eligible for the Retirement Saver's credit? 401k or IRA before HSA, at least to $2k, or $2k each if MFJ.

Eligible for EITC, or could be if lowered AGI? HSA thru payroll deductions and/or t401k, not tIRA or Roth.

Filing FAFSA for dependents? HSA thru payroll deductions, possibly additional t401k or tIRA to lower AGI to meet Simplified Needs Test, or meet auto EFC = 0.

Not familiar with Retirement Saver's credit, but glanced at requirements and I think income is too high (30-40's). I think EITC runs into same problem. Not sure where FAFSA fits in but he's already finished college and no immediate plans for more schooling. A current student making 5-10k a year might benefit from all these programs, but Retirement Saver's credit seems to be a cruel joke, and EITC has many conditions that seems to exclude most students.

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grabiner
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Re: HSA vs 401k vs other - low tax bracket

Postby grabiner » Fri Mar 17, 2017 8:34 pm

deltaneutral83 wrote:HSA is the answer. HSA's are payroll tax exempt which nothing else is. 7.65% of $3,400 is $260 bucks per year individually.


This isn't an advantage for someone in a low tax bracket; see Payroll Deduction: Health Savings Account on the wiki. If your average income, adjusted for inflation, is less than the second SS bend point ($61,884 in 2017), funding an HSA by payroll deduction costs you more in SS benefits than it saves you in taxes. If you are above the second bend point, it's close to break-even.

But there is still the 15% federal tax. If you have $1700 in cash, you can put $1700 in a Roth IRA which will grow tax-free, or $2000 in an HSA which will also grow tax-free. That is a better deal than anything except a 401(k) with an employer match.
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teen persuasion
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Re: HSA vs 401k vs other - low tax bracket

Postby teen persuasion » Sat Mar 18, 2017 7:49 am

inbox788 wrote:
teen persuasion wrote:Need more details.

Will he be eligible for the Retirement Saver's credit? 401k or IRA before HSA, at least to $2k, or $2k each if MFJ.

Eligible for EITC, or could be if lowered AGI? HSA thru payroll deductions and/or t401k, not tIRA or Roth.

Filing FAFSA for dependents? HSA thru payroll deductions, possibly additional t401k or tIRA to lower AGI to meet Simplified Needs Test, or meet auto EFC = 0.

Not familiar with Retirement Saver's credit, but glanced at requirements and I think income is too high (30-40's). I think EITC runs into same problem. Not sure where FAFSA fits in but he's already finished college and no immediate plans for more schooling. A current student making 5-10k a year might benefit from all these programs, but Retirement Saver's credit seems to be a cruel joke, and EITC has many conditions that seems to exclude most students.

Agreed that the Retirement Saver's credit is a cruel joke - it seems expressly designed so that no one can claim it fully, as it is not refundable.

Lower your AGI (thru HSA and 401k contributions) to be in the max credit range, and your tax is negligible. Decide instead to increase AGI a tiny bit, and credit rate drops precipitously to where it no longer covers tax owed. Student? Not eligible. Withdrawals in a 3 year window? Effectively not eligible - withdrawal amount reduces both spouses' contributions.

deltaneutral83
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Re: HSA vs 401k vs other - low tax bracket

Postby deltaneutral83 » Sat Mar 18, 2017 1:04 pm

grabiner wrote:
deltaneutral83 wrote:HSA is the answer. HSA's are payroll tax exempt which nothing else is. 7.65% of $3,400 is $260 bucks per year individually.


This isn't an advantage for someone in a low tax bracket; see Payroll Deduction: Health Savings Account on the wiki. If your average income, adjusted for inflation, is less than the second SS bend point ($61,884 in 2017), funding an HSA by payroll deduction costs you more in SS benefits than it saves you in taxes. If you are above the second bend point, it's close to break-even.

But there is still the 15% federal tax. If you have $1700 in cash, you can put $1700 in a Roth IRA which will grow tax-free, or $2000 in an HSA which will also grow tax-free. That is a better deal than anything except a 401(k) with an employer match.


I took this into account and since the OP was referencing someone young, I assume they were greater than 35 years away from retirement for SS calculations (although he may want to retire at 40 like the rest of us so he needs every year he can get)? Money in an HSA can be put into index funds which will outpace the SSI returns, a guarantee, no, a strong likelihood, yes. Then there's the elephant in the room; the solvency of SSI for someone under 30, and quite frankly, someone under 45.

I'll turn that $260 from savings on FICA taxes into much more than I lose in SSI benefits in 30/35/40 years, right? Or at least it's a risk I'm more than comfortable taking. If I'm going wrong somewhere, please advise.

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Re: HSA vs 401k vs other - low tax bracket

Postby grabiner » Sat Mar 18, 2017 3:22 pm

deltaneutral83 wrote:I'll turn that $260 from savings on FICA taxes into much more than I lose in SSI benefits in 30/35/40 years, right? Or at least it's a risk I'm more than comfortable taking. If I'm going wrong somewhere, please advise.


The reason to compare things at the same risk level is that you can change your risk level freely. If you pay the $260 in FICA taxes, you can still move $260 from a bond fund to a stock fund, getting the same risk (and expected return) increase as if you avoided the FICA tax and put $260 in a stock fund.

The break-even, as noted on the wiki, is 214 months if you are over the second bend point and your low-risk investments match inflation. Young investors can invest in long-term TIPS, which yield about 1% above inflation with no risk, so if you aren't maxing out your IRA/401(k), and are above the second bend point, it is probably better to avoid the taxes. But below the second bend point, the break-even is 100 months, and even adjusting that to 150 if your cumulative returns are 50% above inflation makes it worthwhile paying the FICA.

There is an exception if the current year will not be one of your 35 highest-earning years, or if you will have spouses or widow(er)'s benefits for most of your SS earning period. Conversely, if you have a lower-earning spouse who is likely to outlive you (and thus your benefit will last longer than your life), paying more FICA is even more desirable.
David Grabiner

inbox788
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Re: HSA vs 401k vs other - low tax bracket

Postby inbox788 » Mon Mar 20, 2017 2:16 pm

Thanks everyone for all the added nuances to this dilemma. I've concluded that HSA vs Roth are both decent options and depending on situation and assumptions, one may choose one or another. I will be recommending HSA first for now and then Roth. Both are essentially emergency funds, with HSA having a little more benefit early on trading off for limited use.


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