The HSA and 401k are complementary benefits. Done right, they are better together. As Rocky Balboa once said in explaining his affection for Adrian[i], “… she’s got gaps, I got gaps, together we fill gaps.”
Why are the HSA and 401k better together? A participant who carefully allocates savings between the two benefits can shape how each is used, today and tomorrow, so as to maximize the net after-tax value achieved from savings[ii]:
- Leveraging features that are superior in each plan, to
- Meeting short-term, intermediate, and long term needs along the way to and throughout retirement.
Here’s a side-by-side comparison—confirming superiority feature-by-feature basis (green):
Recap:
- Contribution limits: 401k superior, higher amounts.
- Liquidity for non-medical financial needs: 401k superior (where the plan offers loans).
- Portability/Investment Selection: HSA superior, always portable, investments comparable to IRAs.
- Vesting – Employer Contribution: HSA superior, always vested[iii].
- Tax preferences—contributions: HSA superior, employee contributions via cafeteria plans are pretax not only for federal and state income taxes, but also for FICA and FICA-Med. Employer contributions are deductible for federal and state income tax purposes and pre-tax for FICA, FICA-Med.
- Tax preferences on distributions: HSA superior, most medical, dental, vision, hearing, and long-term care (LTC) expenses are eligible for tax-free reimbursement, while employed and post-separation/in retirement. Medicare, COBRA and certain LTC premiums, as well as retiree contributions towards the cost of employer-sponsored retiree medical coverage, are also eligible for tax-free reimbursement using HSA assets. 401k distributions do not receive tax-preferred treatment – whether employee pre-tax or employer contributions, or earnings thereon. When HSA monies are distributed after age 65 but are not used to reimburse qualifying medical expenses, HSA monies are superior because HSA contributions via the cafeteria plan avoided FICA and FICA-Med.
What does that mean, in practical terms, when it comes to funding what will be the largest expense in retirement for most Americans – health care? It may create a 60% increase in value!
Yes, HSA and 401k–better together!
Part 1 of this three-part series focused on the lack of access to Health Savings Account coverage. Stay tuned for Part 3, which will complete the discussion by outlining 10 Top Risks in Offering Health Savings Accounts.
I am always interested in your comments, corrections, criticisms, and suggestions. Happy to guide you should you decide to introduce HSA-capable coverage alongside your 401k. Feel free to e-mail me at jacktowarnicky@gmail.com
Disclaimer No. 1: My comments are my own based on my past experiences in plan sponsor and consulting roles and do not necessarily reflect those of any employer or association I have been employed by or affiliated with, past, present, or future.
Disclaimer No. 2: Information was provided by individuals with knowledge and experience in the industry and not as legal or tax advice. The issues presented here may have legal implications, and you should discuss this matter with legal counsel prior to choosing a course of action. This article is intended to be informational only. It is not (and you/others should not use it as a substitute for legal, accounting, actuarial, or other professional advice. Any advice contained in this article was not intended or written to be used and cannot be used by anyone for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person [or to promote, market or recommend any transaction or subject addressed herein]. You (others) should seek advice based on your (their) particular circumstances from an independent tax advisor.
[i] Rocky, United Artists, 1976.
[ii] J. Towarnicky, Maximum Utility: Your HSA Can Do “Quadruple Duty,” Benefits Quarterly, 2nd Quarter 2021.
[iii] Author’s Note: Depends on perspective. Worker perspective shown. However, a plan sponsor may prefer the 401k vesting as a means of managing expense for short service workers and/or as a retention device.
Jack Towarnicky provides independent benefits consulting and serves as a member of aequum, LLC and of counsel for Koehler Fitzgerald, LLC.
