Investing in Your HSA vs. Your 401(k)

by Carrie Pallardy | Originally posted on Investopedia

Health Savings Accounts (HSAs) and 401(k) plans are offered by many employers in the United States. Both HSAs and 401(k) plans can offer tax benefits, but these two types of accounts have distinct purposes and rules. What is the difference between your HSA and your 401(k)?

How an HSA Works

An HSA is a savings account paired with a high-deductible health plan (HDHP). In 2022, HDHPs have an annual deductible of $1,400 or more for individuals and $2,800 or more for families. The health plan also must have limits on out-of-pocket medical expenses. In 2022, out-of-pocket expenses cannot exceed $7,050 for individual coverage and $14,100 for family coverage.

To make HSA contributions, you must have an HDHP. Additionally, you cannot have other health coverage or be enrolled in Medicare. You also cannot be claimed as a dependent on someone else’s tax return.

Typically, you cannot use your HSA to pay for premiums. The funds in the account can be used to pay for expenses like your deductible, co-payments, and co-insurance.

The money in the account accrues tax free, and you have the option of investing HSA funds to potentially increase your returns.

How a 401(k) Works

A 401(k) is a retirement savings plan that allows employees to contribute money, often through payroll deductions, to an investment account. Employers can elect to match all or some of employees’ 401(k) contributions. You typically have the option to choose from different investment types, often mutual funds, for your 401(k).

Traditional and Roth are the two main types of 401(k) plans, and tax treatment is the primary difference between these two options. With a traditional 401(k), you will wait to pay taxes until you withdraw money from the account, typically in your retirement years. With a Roth 401(k), you contribute money after taxes, which means that withdrawals in your retirement years will be tax free.

What Are the Contribution Limits?

Each year, the Internal Revenue Service (IRS) sets contribution limits for HSAs and 401(k)s. In 2022, individuals can contribute up to $3,650 to their HSAs. Individuals with family health coverage can contribute up to $7,300.7 Individuals who are age 55 or older can make an annual catch-up contribution, an additional $1,000. These limits include any contributions made by the individual and the employer.

If you make HSA contributions that exceed the limit set by the IRS, the excess amount will generally be subject to a 6% excise tax.