Saving for Retirement and Potential Health Care Costs
Your friend Jody has recently started a new job and she has several options for saving for her retirement and future health care costs.
Jody’s new employer offers a 401(k) with a match of up to 3% of her salary. They also offer a Health Savings Account (HSA) option. Jody lives in a state that does not tax withdrawals from HSAs for qualified medical expenses and contributions to HSAs may be deducted from taxable income for state income tax purposes.
In addition, Jody also has a Roth IRA which she is using to save for her retirement.
Jody is in very good health and would prefer to have a health plan that limited her upfront health care costs while allowing her to save for future expenses. She is comfortable with a high deductible plan. She is financially secure and doesn’t plan on touching the money in her Roth IRA until retirement.
Assume Jody meets the eligibility requirements to participate in her employers 401(k) program, enroll in a Health Saving Account, and simultaneously has enough to contribute to a Roth IRA.
How should Jody prioritize her saving among these choices?
- Contribute to her Roth IRA first, then contribute to her HSA, then contribute to her 401(k) up to the match amount
- Contribute to her 401(k) up to the match amount first, then contribute to her HSA, then contribute to her Roth IRA
- Contribute to her HSA first, then contribute to her 401(k) up to the match amount, then contribute to her Roth IRA
- Contribute to her Roth IRA first, then contribute to her 401(k) up to the match amount, then contribute to her HSA
Solution:
2 is probably the best answer.
The first priority of saving for retirement is contribute to a 401(k) at least up to the employer match amount. Think of it this way, the match amount is free money that you otherwise wouldn’t get.
If Jody is comfortable with a high deductible health care plan, she should next contribute to a Health Savings Account, which has more tax benefits than a Roth IRA. HSAs offer a triple tax benefit – the contributions will reduce your taxable income, the contributions will grow tax-deferred, and can be withdrawn tax-free provided they are used for qualified medical expenses, which can include prescriptions, office visits, etc. depending on the plan. Once you reach age 65, you can also withdraw money from an HSA to pay for non-medical expenses, but the funds will be taxed as income (similar to a withdrawal from a traditional IRA).
It’s important to note though that an HSA is not necessarily a good option for everyone. You’re only able to contribute to an HSA if you have a high deductible health plan. If you withdraw funds for non-qualified expenses before you turn 65, you’ll owe taxes on the withdrawal amount plus a 20% penalty. Also, not all state tax laws align with federal tax laws on HSAs, so there are states where HSAs offer little to no tax benefit on state income taxes.
If you’re uncomfortable with a high deductible health care plan and/or may need funds for non-health care related expenses before retirement then a Roth IRA makes more sense as a savings vehicle than an HSA.
Also, a Roth IRA provides greater flexibility since funds can only be withdrawn from an HSA without penalty for qualified medical expenses. In this particular scenario, it doesn’t appear that Jody needs the greater flexibility of a Roth IRA but she should consider working with a financial advisor who can guide her through scenarios like this.
The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice, either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.
This quiz is intended for informational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information presented is general information that does not take into account your individual circumstances, financial situation or needs, nor does it present a personalized recommendation to you. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy.
