Suppose you want to best utilize $100. You could put it to work in a traditional or Roth defined contribution (DC) retirement plan, a Health Savings account (HSA), or a 529 plan. Where would you get the biggest bang for the buck? To find out, let’s run a race among them.
Assuming the accounts are being used for the purposes they are primarily designed for, the seemingly simple decision of where to put the money triggers multiple tax implications. To a great degree, the tax code determines which is faster.
Using a representative worker ($50,000 earnings at age 25, retirement at age 65, a simple 5 percent investment return across plans), let’s head to the races.
Here are the results:
- HSA always wins out. It reaps the full force of contributions and investment returns given its triple tax exemptions, upfront and afterward, as long as the account is used for healthcare.
- Retirement accounts, traditional and Roth, supersede 529 when these accounts have the chance to run the full course.
- When the race is for an equal length of time, 529 could beat Roth because the upfront taxes on Roth cut the horse too lean and it fails to catch up with the state tax exemption granted to 529 accounts.
What vehicle wins the race if the employers choose to finetune the engines, more specifically by matching contributions? Assuming the employer matches 50¢ for each $1 saved by the employees to their retirement accounts, the funding priority should be:
- Traditional
- Roth
- HSA
- 529
The employer match has significantly changed the race. The ranking echoes the conventional wisdom that workers should capture the employer match.
When employer match is on the table is it always wise to put retirement plans ahead of the HSA? Not necessarily. When the worker income is sufficiently high (for instance, more than $200,000 for a single taxpayer), the vehicles reshuffle.
Even with employer match, traditional and Roth accounts could cease to be superior to HSA because the action of saving in retirement accounts could invoke high taxes on both employee and employer contributions.
Overall, U.S workers have a limited budget and thus seek to put their resources to the best use. The financial plans available can be complex and difficult to understand, however. Careful consideration of the details can guide the decision of where best to park those investments.
Running the races, we illustrate it is generally wise for workers to help themselves out first, by saving for their retirement and healthcare, before helping others by contributing to 529 accounts for the benefit of their children or grandchildren.
It is a serious misuse of HSAs if the owners simply treat them as specialized checking accounts. Rather, HSAs can serve well as the second, if not primary, powerhouse of long-term investment. They are tax-free for healthcare purposes and can team up with DC plans for general retirement purposes.
For most workers, the best option for their money is in their DC plan if they get the employer match. Otherwise, HSA is a better vehicle, on the condition that investment strategies and costs are comparable in these plans.
For a more detailed analysis, please see “A Horse Race – 401K vs. 529 vs. HSA vs. Roth” accessed 01/2018 https://www.northerntrust.com/documents/white-papers/asset-management/a-horse-race.pdf?bc=25262982.
Prior to his tenure at TIAA, Dr. Pang served as Head of Quantitative Strategy at Smart USA, a global retirement technology provider. In this role, he supervised quantitative ideation and strategies in technology-enabled solutions for lifelong financial planning and investment management, led methodologies and algorithms for optimization, and built prototypes for software and platform innovations. His earlier experience includes serving as a Senior Vice President at Northern Trust Asset Management, where he led advanced analytics and developed optimal strategies within the life cycle framework, with a special focus on behavioral finance.
Dr. Pang's research contributions are notable, particularly in the realm of retirement income strategies. He co-authored a study with economist Mark Warshawsky, supported by the American Council of Life Insurers (ACLI), which found that combining systematic withdrawals with annuities can lead to better retirement income outcomes than the traditional 4% withdrawal rule. This research has influenced discussions on retirement planning, emphasizing the value of annuities in providing stable income streams.
In recognition of his scholarly work, Dr. Pang received the Best Article Award for his piece in the "Risk Management and Insurance Review" and was a finalist for the TIAA Paul A. Samuelson Award for Outstanding Scholarly Writing on Lifelong Financial Security.