Why HSAs are 25% better than 401Ks

Among all tax advantaged accounts, the Health Savings Account (HSA) is the only one offering triple+ tax benefits. Let’s look deeper at how these benefits play out.

Imagine Sarah and Steve – both 28 years old –  decide to start setting aside some money to pay for the healthcare costs in retirement (by the estimates from Fidelity, a married couple retiring today, will need to pay on average $285,000 out of pocket to cover their healthcare costs). Both earn $100,000 and can set aside $1,000 per year for this purpose. Sarah chooses to start contributing to HSA (and invest all the balance) while Steve decides to add extra $1,000 contribution to his 401K.

By the time Sarah and Steve reach 60, they both have contributed $32,000 by payroll deductions.

As Sarah is using HSA account, her contributions are exempt from FICA (Social Security and Medicare) taxes – for her income level, the savings are equal to 6.2% per year or $62. Sarah decides to put these savings to her HSA as well.

Assume all the investments grow on average 7% a year for Sarah and Steve.

When Sarah reaches 60, she has $116,547 in her HSA account: $32,000 of initial contributions, $78,218 of compounded interest and $6,329 of reinvested FICA savings over the years.

Steve is not far behind – the portion of his 401K account balance that he set up for this purpose, has reached $110,218: $32,000 of initial contributions and $78,218 of compounded interest. 401K accounts are not exempt from FICA taxes, so Steve has missed $6,329 compared to Sarah so far.

Now time comes to spend the money to cover healthcare expenses in retirement. Sarah can withdraw her balance from HSA account tax free.

Steve, though, has to pay taxes as withdrawals from 401K are taxed as ordinary income. Assume Steve is in the 15% tax bracket – taxes will deplete his account balance by $16,533.

You can see that just by choosing the type of account, Sarah was able to save $23K or 25% more compared to Steve.