HSA/401(k) eating away SEP-IRA

[bogleomics]

My company has a generous SEP-IRA retirement plan, of which they typically give eligible employees a 15% contribution.

The company's contribution is based on Box 5 of the W2 (Medicare wages). So that means that if I make any 401(k) or HSA contributions, that portion is not present in Box 5 and thus I don't get 15% of it. (In a few years in the past, the SEP has been at only 10%).

I've opened a separate HSA that I've contributed to with after-tax dollars, figuring it's better to make 15% minus FICA taxes of 7.65% - though that's about a wash, if I'm calculating correctly.

I haven't made any 401(k) contributions yet because: 1) the SEP is generous, 2) I max out my IRA, 3) the 401(k) has no match. I could see myself in the near future doing so, but the after-tax contributions to the HSA first might be the better path because that's invested in the S&P 500.

Questions:

Am I thinking about this correctly -- that I should continue prioritizing SEP earnings and take the FICA tax loss when contributing to the HSA with after-tax monies? And if I wanted to contribute beyond my IRA, that I should prioritize maxing out the HSA over a 401(k)?

Are there any other considerations I should take into account to maximize this benefit and reduce taxes?

Thank you very much for your assistance. This is a great forum.

[Duckie]

bogleomics, welcome to the forum.

Am I thinking about this correctly -- that I should continue prioritizing SEP earnings and take the FICA tax loss when contributing to the HSA with after-tax monies? And if I wanted to contribute beyond my IRA, that I should prioritize maxing out the HSA over a 401(k)?

Your W-2 Box 1 is taxable income minus your pre-tax 401k contributions. Your Box 3 for social security and Box 5 for medicare both include the 401k contributions. See here.

• "Box 3 & 5 (Social Security and Medicare wages) - Include all employee pre-tax, after-tax and designated Roth contributions."

That means any pre-tax 401k contributions not only reduce your taxable income but are also eligible for the 15% company contribution. On the other hand, your HSA contributions do not appear in boxes 1, 3, or 5 so those contributions through your employer would reduce the 15%. (They appear in box 12 code W.) Given that, I would prioritize the pre-tax 401k over the HSA.

[queenofthemadhouse]

You might consider funding your HSA outside of payroll. You might need your own account. You’d pay extra Medicare tax, and maybe extra OASDI tax, but it wouldn’t t impact Box 5, and you just deduct in on your 1040 (above the line).

[grabiner]

You might consider funding your HSA outside of payroll. You might need your own account. You’d pay extra Medicare tax, and maybe extra OASDI tax, but it wouldn’t t impact Box 5, and you just deduct in on your 1040 (above the line).

And this might not even cost you in the long run; you would pay more Social Security tax, but get a higher Social Security benefit.

[Duckie]

You might consider funding your HSA outside of payroll. You might need your own account. You’d pay extra Medicare tax, and maybe extra OASDI tax, but it wouldn’t t impact Box 5, and you just deduct in on your 1040 (above the line).

He already is doing that:

• "I've opened a separate HSA that I've contributed to with after-tax dollars, figuring it's better to make 15% minus FICA taxes of 7.65% - though that's about a wash, if I'm calculating correctly."

[queenofthemadhouse]

Hmm. I missed that. Though I don’t see how it’s a wash, as OP said.

[bogleomics]

bogleomics, welcome to the forum.

Am I thinking about this correctly -- that I should continue prioritizing SEP earnings and take the FICA tax loss when contributing to the HSA with after-tax monies? And if I wanted to contribute beyond my IRA, that I should prioritize maxing out the HSA over a 401(k)?

Your W-2 Box 1 is taxable income minus your pre-tax 401k contributions. Your Box 3 for social security and Box 5 for medicare both include the 401k contributions. See here.

• "Box 3 & 5 (Social Security and Medicare wages) - Include all employee pre-tax, after-tax and designated Roth contributions."

That means any pre-tax 401k contributions not only reduce your taxable income but are also eligible for the 15% company contribution. On the other hand, your HSA contributions do not appear in boxes 1, 3, or 5 so those contributions through your employer would reduce the 15%. (They appear in box 12 code W.) Given that, I would prioritize the pre-tax 401k over the HSA.

Thank you. That's a helpful link from the IRS, and a new piece of information I didn't know (that Boxes 3 & 5 include the contributions).

An additional factor on this: My wife and I currently max out our Roth IRAs. My company's 401(k) is in Vanguard, and has a 0.5% management fee over the course of the year (divided by four and then calculated quarterly based on the average balance in the account each quarter). My HSA is in Fidelity, with no fees other than the expense ratio for FXAIX.

Given that, plus what I say further below about 401(k) vs. HSA being a wash (which I could be wrong about), would you still prioritize 401(k) over HSA? Is there another reason you see which makes that preference more attractive in this decision?

You might consider funding your HSA outside of payroll. You might need your own account. You’d pay extra Medicare tax, and maybe extra OASDI tax, but it wouldn’t t impact Box 5, and you just deduct in on your 1040 (above the line).

Indeedy -- I have an HSA through Fidelity (a second HSA account not directly connected to my employer's health insurance), and have deducted on federal income taxes when I've contributed outside of my employer's contributions.

You might consider funding your HSA outside of payroll. You might need your own account. You’d pay extra Medicare tax, and maybe extra OASDI tax, but it wouldn’t t impact Box 5, and you just deduct in on your 1040 (above the line).

And this might not even cost you in the long run; you would pay more Social Security tax, but get a higher Social Security benefit.

That's an interesting tidbit I didn't think of. I'm trying to base my retirement plans as if Social Security won't be there, but happy to receive what I can at retirement age. I'll have to dig into how the formula works and how much it would affect the benefit under the current formula.

Hmm. I missed that. Though I don’t see how it’s a wash, as OP said.

The wash I meant was 15% (SEP bonus) minus 7.65% FICA taxes by contributing to HSA with after-tax dollars equaling 7.35% benefit (versus contributing to HSA pre-tax, losing the 15% benefit but saving on 7.65% FICA taxes). I could very well be looking at this the wrong way; please let me know.

Are there any other long-term effects I'm not seeing in my thinking?

Thank you very much for your replies!

[pasadena]

So since Box 5 includes an PT 401(k) contributions, this might be a moot point, but if your 401(k) has a Roth option, it may be worth looking into that too. Whether it's better than PT depends mostly on your tax rate (marginal) and anticipated tax rate in retirement.