HSA vs 401K

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markcoop
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HSA vs 401K

Post by markcoop » Fri Nov 21, 2014 11:25 am

I'm considering enrolling in a health plan with an HSA in 2015 for the first time. From what I'm reading, an HSA has the following benefits for me when I use payroll deduction:

1) Tax-free going in
2) No FICA going in
3) Tax-free going out (as long as used for medical)

That being the case, this money is getting greater preferential treatment than a 401K (or any other tax-advantaged account). This is like getting the tax benefits of a ROTH IRA and a traditional IRA. Not sure if this difference is even greater factoring in the FICA taxes (no idea if FICA is being taken out of 401K contributions or 401K ROTH contributions).

A quick example shows how powerful this can be (assume 25% tax bracket, money multiplies by 10 over the years and compare to a 401K):

Case 1 No HSA: Invest $1,000 pretax dollars. Grows to $10,000 till retirement. If withdraw the whole amount, worth $7,500.

Case 2 HSA: Invest the $1,000 in an HSA with pretax dollars. Grows to $10,000 till retirement. If withdraw the whole amount for medical, worth $10,000.

Sure there are some assumptions here: same tax-bracket, the whole amount taxed at marginal rate in case 1, the fees are the same in the HSA and 401K. I like to make strong assumptions to understand an issue and then relax them.

So, given the info above, it would seem maxing out an HSA is probably more important than maxing out a 401K. Even if you relax some of those assumptions, I'd think the HSA money would win out. If one is already maxing out the HSA, then I would think it's better to pay off the medical bills and keep the money in the HSA rather than invest in a 401K.

Opinions?
Mark

asif408
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Re: HSA vs 401K

Post by asif408 » Fri Nov 21, 2014 11:30 am

I would agree with you unless you get a match in your 401k. With a match you are getting free money (basically a 100% return, if I am thinking about this correctly), so any 401k money up to the match would trump HSA contributions.

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markcoop
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Re: HSA vs 401K

Post by markcoop » Fri Nov 21, 2014 12:16 pm

asif408 wrote:I would agree with you unless you get a match in your 401k. With a match you are getting free money (basically a 100% return, if I am thinking about this correctly), so any 401k money up to the match would trump HSA contributions.
Yes, I agree. I would going to mention that, but didn't.
Mark

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tainted-meat
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Re: HSA vs 401K

Post by tainted-meat » Fri Nov 21, 2014 12:23 pm

The HSA is a great investment, especially if you are under the FICA phaseout range.

Like the previous poster said, go for the match, then do the HSA to the max.

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TomatoTomahto
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Re: HSA vs 401K

Post by TomatoTomahto » Fri Nov 21, 2014 12:24 pm

I agree generally, but two points to consider:

1. The FICA bypass is only useful for people making less than the cutoff
2. There are receipt-keeping requirements, especially if your HSA grows 10x as your example indicates. Coming up $5500 in medical is not usually a problem, but if your HSA grows to $55,000 for every year you're in, well, you might not survive the medical intervention :oops:

Anyway, generally I agree, and have referred to HSA as a "Super IRA" to friends.
Okay, I get it; I won't be political or controversial. The Earth is flat.

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markcoop
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Re: HSA vs 401K

Post by markcoop » Fri Nov 21, 2014 4:50 pm

TomatoTomahto wrote:2. There are receipt-keeping requirements, especially if your HSA grows 10x as your example indicates. Coming up $5500 in medical is not usually a problem, but if your HSA grows to $55,000 for every year you're in, well, you might not survive the medical intervention :oops:
The receipt-keeping does seem like a daunting task. At this point, just trying to understand the attractiveness of the HSA. I just found out that my company uses Fidelity and they pay the administrative fee. So, I believe you can get a total stock market index fund with a total cost of 0.5%. Seems like a pretty attractive option. I'm hoping I can max out both the 401K and HSA. If I can't, I believe I will not contribute as much to the 401K (which also has very low fees) unless I'm missing something.
Mark

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Re: HSA vs 401K

Post by TradingPlaces » Fri Nov 21, 2014 4:58 pm

Some things to remember about HSA:

1. HSA contributions not subject to FICA only if these are employer contributions, i.e., via payroll deduction. If you contribute from your own bank account (assuming eligible), IMO you can't avoid paying FICA taxes,

2. Depending on your income, tax bracket, and number of years worked, $1 put into HSA might cause you to lose a lot more than $1 in social security old age benefits. While a very degenerate case, this applies to either new immigrants, or people who spend very little time in the work force. At any rate, something to keep in mind,

3. Investment options might be limited in an HSA. Even good HSAs might not give you investment options until your balance reaches a certain threshold. Furthermore, even if you reach that threshold, you might not be able to contribute 100% of your balance to investments, instead having to keep a certain percentage in cash. Also, fees in HSA can be high.

All in all, if you do careful planning, HSA is a good tool to have in your toolbox.
Last edited by TradingPlaces on Fri Nov 21, 2014 5:01 pm, edited 1 time in total.

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Re: HSA vs 401K

Post by TradingPlaces » Fri Nov 21, 2014 5:01 pm

markcoop wrote:
TomatoTomahto wrote:2. There are receipt-keeping requirements, especially if your HSA grows 10x as your example indicates. Coming up $5500 in medical is not usually a problem, but if your HSA grows to $55,000 for every year you're in, well, you might not survive the medical intervention :oops:
The receipt-keeping does seem like a daunting task. At this point, just trying to understand the attractiveness of the HSA. I just found out that my company uses Fidelity and they pay the administrative fee. So, I believe you can get a total stock market index fund with a total cost of 0.5%. Seems like a pretty attractive option. I'm hoping I can max out both the 401K and HSA. If I can't, I believe I will not contribute as much to the 401K (which also has very low fees) unless I'm missing something.
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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Re: HSA vs 401K

Post by TradingPlaces » Fri Nov 21, 2014 5:04 pm

TomatoTomahto wrote:I agree generally, but two points to consider:

2. There are receipt-keeping requirements, especially if your HSA grows 10x as your example indicates. Coming up $5500 in medical is not usually a problem, but if your HSA grows to $55,000 for every year you're in, well, you might not survive the medical intervention :oops:
But there is something very beautiful in receipt keeping. You can retroactively use unused receipts to take money out without paying taxes!

Imagine you accumulate $500 of medical expenses per year (deductibles, co-pays, drugs, dental work, etc). You meticulously keep these receipts. You accumulate $15K of receipts over years. And then one year, you just take out $15K of money out of the HSA. Double that for spouse. In fact, one would argue that $500 per year is on the low end, and on occasional years, you might have $1-2K of out-of-pocket, qualified medical expenses.

How long is the receipt keeping requirement? 3 years? 6 years? In other words, if they don't audit you, can you throw away already-used-up receipts?

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Re: HSA vs 401K

Post by TomatoTomahto » Sat Nov 22, 2014 8:03 am

TradingPlaces wrote:But there is something very beautiful in receipt keeping. You can retroactively use unused receipts to take money out without paying taxes!
In principle, yes. For reasons extraneous to this thread, we will only have a two-year accumulation of HSA money, so a lowish 5-digit amount. Quite likely I will be the first to die (older, male, etc.). My wife, who isn't interested in these machinations, will not want to invest the time and energy to manage the withdrawal of tax-free growth. If it were a much larger amount, I'd insist, but I've decided to take the sub-optimal limited benefit and spend it as we go.

In New Jersey:
there is no state tax benefit
my wife's income is beyond the SS max
we do save 1.45% on Medicare tax and an additional 0.9% on income >$250k
we save on Federal income tax

It will have to be good enough :D , without the benefit of tax-free growth.
Okay, I get it; I won't be political or controversial. The Earth is flat.

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Re: HSA vs 401K

Post by TradingPlaces » Sat Nov 22, 2014 1:12 pm

There are other ways to milk the HSA, especially if your company will thrown you in a bone. E.g., assume you are relatively healthy, and relatively sure of it:

1. Alternate between getting HDHP/HSA and a "Cadillac" health plan,
2. Years when you are on HDHP/HSA, defer all non-essential health car costs,
3. Years when you are on the "Cadillac" do all your health planning, e.g., that expensive test that can be delayed,
4. Maybe company will thrown in $250-$1000 into your HSA, from their funds?

Even better if you have qualifying event, or changing jobs:
1. If changing jobs early in the year, and you know it, fund FSA to the max. You will get 100% of the funds, possibly, as of Jan 15th. However, you will contribute only pro-rata number of days / weeks worked,
2. Try to spend the FSA. There are ways to "pre-spend",
3. In the new job, sign up for HSA, if available.

zaphoyd
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Re: HSA vs 401K

Post by zaphoyd » Sat Nov 22, 2014 1:20 pm

TradingPlaces wrote:Some things to remember about HSA:
2. Depending on your income, tax bracket, and number of years worked, $1 put into HSA might cause you to lose a lot more than $1 in social security old age benefits. While a very degenerate case, this applies to either new immigrants, or people who spend very little time in the work force. At any rate, something to keep in mind,
I'm curious to learn more about this aspect of avoiding FICA tax re: HSAs vs 401K. Do you know of any other threads or articles that discuss this in more detail?

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Re: HSA vs 401K

Post by jeffyscott » Sat Nov 22, 2014 3:46 pm

TomatoTomahto wrote:If it were a much larger amount, I'd insist, but I've decided to take the sub-optimal limited benefit and spend it as we go.
I don't think it is suboptimal, unless you are maxing out 401K and Roth and still have enough after-tax money to pay the bills while leaving the HSA alone.

I'll have only 2-3 years of payroll deduction funding the HSA, but even after retirement will continue to add to it. This will allow me to do a tax-free conversion from tax deferred to tax-free (if used for medical).
Time is your friend; impulse is your enemy. - John C. Bogle

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Re: HSA vs 401K

Post by TomatoTomahto » Sat Nov 22, 2014 4:48 pm

jeffyscott wrote:I don't think it is suboptimal, unless you are maxing out 401K and Roth and still have enough after-tax money to pay the bills while leaving the HSA alone.
We do have enough to do that, but the HSA goes into taxable saving not spending. My wife is in her peak earning years at a time where the mortgage is long gone, the kids' college is taken care of, and we have maxed out tax-advantaged accounts.

It would have been nice to put a few more thousand a year into tax-advantaged space, and I guess I could write up detailed instructions for my wife in the likely event that I predecease her, but in the end, it's just the icing; we've already got the cake.
Okay, I get it; I won't be political or controversial. The Earth is flat.

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Re: HSA vs 401K

Post by grabiner » Sat Nov 22, 2014 5:03 pm

zaphoyd wrote:
TradingPlaces wrote:Some things to remember about HSA:
2. Depending on your income, tax bracket, and number of years worked, $1 put into HSA might cause you to lose a lot more than $1 in social security old age benefits. While a very degenerate case, this applies to either new immigrants, or people who spend very little time in the work force. At any rate, something to keep in mind,
I'm curious to learn more about this aspect of avoiding FICA tax re: HSAs vs 401K. Do you know of any other threads or articles that discuss this in more detail?
You can work it out with the formulas from www.ssa.gov. It is only relevant if you use payroll deduction to avoid FICA taxes.

Usually, payroll deduction is close to break-even, but it can cost more than the tax savings if you have low earnings, or if your spouse will be receiving a lot of benefits based on your earnings.

Your Average Indexed Monthly Earnings is the average earnings of your 35 highest-earning years, adjusted for inflation, divided by 12.

Your Primary Insurance Amount is 90% of the AIME up to the first bend point ($826 in 2015), then 32% of the amount up to the second bend point ($4980 in 2015), and 15% of the amount above the second bend point. If you retire at full retirement age, your benefit will be equal to the PIA; if you retire earlier or later, your benefit will change to reflect the life expectancy change.

Thus, if your income is over the second bend point (average earnings over $59,760), reducing your income this year by $2800 will reduce your average yearly earnings by $80, your AIME by $6.67, and your PIA by $1. That is, the $2800 reduction will cost you $1 per month (adjusted for inflation) every month from the point at which you start taking Social Security.

The $2800 reduction will also save you $214 in SS and Medicare tax. Thus you are saving $214 now and losing $1 per month in inflation-adjusted Social Security, which would take 18 years of earnings to break even (actually slightly longer because the extra $1 might be taxable).

Note that the assumption depends on the 15% multiplier. If your spouse receives a benefit based on your record, the benefit will be half of yours while you are still alive, and all of yours if you die first, so you should not use payroll deduction. If you will be below the second bend point, the benefit multiplier is 32%, so you should again avoid payroll deduction.

Conversely, if you are over the SS maximum, you will save Medicare tax on your HSA contributions, and not reduce your SS, so payroll deduction is a clear gain.
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Re: HSA vs 401K

Post by camillus » Sat Nov 22, 2014 5:18 pm

3) Tax-free going out (as long as used for medical)

--> After age 65, funds can be withdrawn penalty free, receiving the same tax treatment as a 401k or traditional IRA. So an HSA is never worse than a 401k.

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Re: HSA vs 401K

Post by mikep » Sat Nov 22, 2014 7:21 pm

Except in the states that tax them. CA gives no tax break on HSA contributions or growth, so record keeping is a pain since you have a different basis of Fed vs state.

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Re: HSA vs 401K

Post by kazper » Sun Nov 23, 2014 8:00 am

Op
You are in a lucky spot indeed to be able to pay for expenses out of pocket while also funding your hsa and potential 401k.

I too am contemplating the switch from standard to hdhp/hsa but worry about essentially taking money from my retirement and putting it into an hsa. Our normal yearly medical costs are around 3k after prescriptions, visits, and other random costs. We could not afford to fund the hsa while bearing the out of pocket cost for medical costs, especially if something expensive and unusual came along.

I think in your situation, it definitely makes sense to use the hsa. Just make sure not to put yourself in the situation where you need to raid the hsa without medical costs. The penalties are quite steep!

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Re: HSA vs 401K

Post by grabiner » Sun Nov 23, 2014 10:59 am

kazper wrote:I too am contemplating the switch from standard to hdhp/hsa but worry about essentially taking money from my retirement and putting it into an hsa. Our normal yearly medical costs are around 3k after prescriptions, visits, and other random costs. We could not afford to fund the hsa while bearing the out of pocket cost for medical costs, especially if something expensive and unusual came along.
You aren't actually taking money from your retirement when you do this. If your total costs, including premiums, tax savings, and out-of-pocket medical expenses, are lower with the HSA, then you will have more money in the bank for other purposes, and you will thus have more money in your HSA and 401(k) combined. The money that you put in the HSA instead of your 401(k) is money that you don't need to pay out of pocket when you have medical bills, so you have more money left over to put into your 401(k), and money in the HSA not used for immediate expenses is part of your retirement savings.

For example, suppose that you can either pay a $4000 premium for a conventional plan and pay $3000 in medical bills, or pay a $3000 premium for an HDHP, putting $6650 into your HSA, and pay $4500 in medical bills. You have $11,000 available for health care and investing, and are in a 30% tax bracket; premiums are paid by payroll deduction and are thus tax-deductible. Your investments go into a Roth 401(k) (this makes the comparisons simpler).

If you use the conventional plan, you pay $2800 after tax in premiums, and $3000 in medical bills, so you have $5200 to invest in the Roth 401(k). If you use the HDHP, you pay $2100 after tax in premiums, and get a $1995 tax deduction on your HSA, so you have $10,895 combined to invest in the HSA and Roth 401(k). You put $6650 into the HSA, and $4245 into the Roth 401(k). You then pay your $4500 medical costs from the HSA, leaving $2150 in the HSA and $4245 in the Roth 401(k). Both of these will grow tax-free for your retirement, so you are $1195 ahead in this example.

Note that the HSA is not guaranteed to come out ahead. If your expenses under the HSA were instead $6000, you would be $305 behind.
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Re: HSA vs 401K

Post by zaphoyd » Sun Nov 23, 2014 12:06 pm

grabiner wrote:
zaphoyd wrote:I'm curious to learn more about this aspect of avoiding FICA tax re: HSAs vs 401K. Do you know of any other threads or articles that discuss this in more detail?
You can work it out with the formulas from http://www.ssa.gov. It is only relevant if you use payroll deduction to avoid FICA taxes.
...
Thanks. This was very helpful.

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markcoop
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Re: HSA vs 401K

Post by markcoop » Mon Nov 24, 2014 10:29 am

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.
Given the triple tax benefits (tax-free in, no FICA, tax-free out), I believe this order to be true. In fact, the gap between 2 and 3 may be large. In my case my employer pays the administrative fees and I have options like a Fidelity total stock market index fund with an expense ratio of 0.05% (I had the ER wrong above) making that gap even wider.

My plan is to definitely do 1 and 2 above. But the next question is about whether to pay for medical with my next available dollar or add to the 401K and pay the bill from the HSA. The following example illustrates the choice:

$17,500 to invest
HSA limit = $6650
Employer matches dollar for dollar up to $6,000
Medical bills = $4,850

So I contribute $6,000 to the 401K to get employer match. I contribute $6,650 to the HSA. That leaves $4,850 to invest. I now have two options:

a) Pay the medical bills with the $4,850 and leave the HSA to grow.
b) Pay the medical bills from the HSA and invest the $4,850 in my 401K.

I would claim option (a) is much better.
Mark

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markcoop
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Re: HSA vs 401K

Post by markcoop » Mon Nov 24, 2014 11:33 am

markcoop wrote:I would claim option (a) is much better.
After thinking about it a bit, I take back the claim. I think it's easier to think about option (b) with putting the money in a ROTH IRA. In both cases, you have access to the original $4,850 at any time. With a ROTH, you can withdraw your principal contribution and with an HSA, you can retroactively submit bills to access the $4,850. However, in retirement, the ROTH is always tax-free. In retirement, the HSA is only tax-free if you use it for medical. So, I have flip-flopped my opinion and think option (b) is better. Of course, if you can do both (max out 401K/IRA and not dip into your HSA), that's the best option.
Mark

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Re: HSA vs 401K

Post by grabiner » Mon Nov 24, 2014 11:16 pm

markcoop wrote:So I contribute $6,000 to the 401K to get employer match. I contribute $6,650 to the HSA. That leaves $4,850 to invest. I now have two options:

a) Pay the medical bills with the $4,850 and leave the HSA to grow.
b) Pay the medical bills from the HSA and invest the $4,850 in my 401K.

I would claim option (a) is much better.

After thinking about it a bit, I take back the claim. I think it's easier to think about option (b) with putting the money in a ROTH IRA. In both cases, you have access to the original $4,850 at any time. With a ROTH, you can withdraw your principal contribution and with an HSA, you can retroactively submit bills to access the $4,850. However, in retirement, the ROTH is always tax-free. In retirement, the HSA is only tax-free if you use it for medical. So, I have flip-flopped my opinion and think option (b) is better. Of course, if you can do both (max out 401K/IRA and not dip into your HSA), that's the best option.
This is the same conclusion as HSA: How to use the plan on the wiki. Paying current expenses out of pocket is only better if you are maxing out your retirement plan and thus keeping the HSA gives you more tax-deferred savings.
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