The 401(k)-HSA savings rule of thumb works, until it doesn't

Updated December 5, 2023

For a long time, the rule of thumb for helping employees allocate workplace savings between a 401(k) account and a health savings account (HSA) has been relatively straightforward: 

• save up to the percentage of the employer’s 401(k) match to take advantage of “free” money 
• max out savings in an HSA 
• save more in a 401(k) if anything is left over 

The rule of thumb works well, according to financial advisers — until it doesn’t. What does this mean then for the 401(k) or HSA discussion? 

There are plenty of gray areas that can topple the logic or at least make it murky, advisers said. The ultimate answer depends in large part on behavioral economics. It’s a topic that hasn’t been well studied when it comes to HSA savers. 

“I think we’re just scratching the surface on behavior inside HSAs,” said Jania Stout, managing director and co-founder of Fiduciary Plan Advisors. “Now that balances are getting bigger, I think people are starting to pay attention more.” 

Given these comments from financial advisers, is it better for your clients to save for the 401(k) plans or for their health savings accounts? In this article, InvestmentNews might provide some insight. 

401(k) and HSA: a review of the basics 

What is a 401(k) plan? 

Named after the Internal Revenue Code 401(k), the 401(k) plan is offered by many American employers as a retirement savings plan for their employees. This plan gives a number of tax advantages for the account owner.   

An employee who signs up for this agrees to have a percentage of their paycheck paid directly into an investment account every payday.  

Their employer contributes a certain amount to the employee's retirement account based on the employee’s contribution. They can contribute a portion of or the entire amount into the investment account. This is called the “401(k) match”.  

When establishing a 401(k), the employee can then choose from different investments to grow their retirement savings in the account. In most cases, the choices will include mutual funds.  

Key Facts about the 401(k) 

• There are two basic types of 401(k)s—traditional IRA and Roth IRA; both differ primarily in how they're taxed. 
• In a traditional 401(k), employee contributions reduce taxable income, but the withdrawals are taxed. 
• Employee contributions to Roth 401(k)s are made with income that’s net of taxes. While there's no tax deduction in the contribution year, withdrawals are tax-free. 
• Employers can contribute to both traditional and Roth 401(k) plans. 

What is a Health Savings Account or HSA? 

The Health Savings Account was designed to help people save for their medical expenses, but it can work as a retirement savings vehicle as well. To open one, an individual must have a health insurance plan that has high deductibles.  

In 2023, the plan must have a deductible of $1,500 ($1,400 in 2022) or more for an individual or at least $3,000 ($2,800 in 2022) or more for a family.  

Some employers offer HSAs as an employee benefit. In this case, the account works similarly to a 401(k); the employee chooses to defer a percentage of their income, which comes right out of their paycheck. If a company doesn't offer an HSA, but their employees have a qualifying health plan, they can still open and contribute to an HSA on their own. 

In 2023, individuals may contribute to an HSA in amounts of up to $3,850 ($3,650 in 2022), while families may contribute up to $7,750 ($7,300 in 2022).  

Account holders who are 55 and older can put in an extra $1,000 in catch-up contributions. There are companies that even offer an HSA match, but these aren't as common as those who make 401(k) matches. 

Key facts about the HSA 

• To make HSA contributions, one must have a high-deductible health insurance plan.  
• Anyone with an HSA cannot have other health coverage or be enrolled in Medicare.  
• Those with an HSA cannot be listed as dependent on someone else’s tax return. 
• The funds in the HSA account can be used to pay for deductibles, co-payments, and co-insurance but not for premiums.  
• The money in the account can grow tax-free with the option of investing HSA funds for higher returns. 
• The 20% penalty on withdrawals for non-qualified expenses no longer applies when an HSA holder turns 65 
• Unlike 401(k)s, withdrawals from HSAs are tax-free but only when used to pay for qualified medical expenses. Check IRS Publication 502 for a partial list of qualified medical expenses

When it comes to your retirement plans, which is better then? Should you keep depositing your savings into a 401(k) or into an HSA?  

Prioritizing savings: 401(k) vs. HSA 

There is no definite answer to this question. Prioritizing your 401(k) or your HSA each has its own benefits and drawbacks. The answer depends on the needs and circumstances of the individual account holder.  

For the individual investor to know which to give more weight and allocate more resources to, they should consider what they need the funds for. To illustrate:  

The advantage of an HSA is that it can be tapped at any time to pay for medical expenses in an emergency. No need to pay any taxes or early withdrawal penalties.  

Meanwhile, withdrawing from a 401(k) to pay for medical expenses results in having to pay income taxes. An additional 10% penalty fee applies if the withdrawal was made before the account holder turned 59½.  

It’s possible to avoid paying the 10% penalty on the 401(k) withdrawal if there’s supply proof that the money was for a medical emergency. If the account holder has a permanent disability, the penalty may be waived as well. However, income tax still applies.  

In this video, we find out more about some of the benefits of the HSA. The video also discusses why the contributions to HSAs and 401(k)s went up in 2023 and will increase in 2024:  

Should your client need money for medical emergencies, or if they foresee health issues down the road, an HSA would be a better choice over a 401(k). But if they’re saving for retirement and want the freedom to transfer money to a traditional or Roth IRA later, then the 401(k) is their best bet.   

Comparing the 401(k) vs HSA 

In terms of tax implications, flexibility of use, and distributions, here’s a quick comparison between the 401(k) vs HSA: 

As seen in the table, the HSA can have better tax implications compared to the 401(k).  

For instance, HSA contributions do not have any taxes, while 401(k) contributions are subject to FICA payroll taxes. In this case, HSA contributions can go further than 401(k) contributions and can help the account holder save faster. 

There are also no mandatory minimum distributions on an HSA. In a 401(k), the required minimum distributions kick in once the account holder reaches the age of 72.  

HSA account holders also have the benefit of making taxable withdrawals for any expense when they reach 65 years of age – much like a 401(k) plan.  

Any withdrawals from an HSA for qualified medical expenses are also not taxed. So, if you’re likely to have medical expenses or health issues, the HSA can give better savings.  

Age limits for contributions 

If your clients are concerned about medical expenses upon retirement and are thinking about prioritizing HSA over 401(k), they shouldn’t jump the gun just yet.  

The HSA mandates that if anyone who works past 65 and doesn’t have Medicare will have to stop contributing to their HSA 6 months before they receive Social Security.  

The minute they start drawing on Social Security after retirement age, Medicare coverage becomes mandatory. They cannot contribute to their HSA any longer.  

And before we go into what happened to the age limits for contributions of the 401(k), here are some interesting changes to expect in 2024:  

On the other hand, the 401(k) plan has undergone some major changes. Age limits for making contributions have been removed. Until 2019, anyone who reached the age of 70½ had to stop contributing to their traditional or Roth IRAs – as well as to their 401(k).  

But since 2020, the IRS removed the age limits for making contributions to all these accounts. So now, anyone over 72 can continue to contribute to their 401(k) if they can work or want to do so.  

Minimum distributions are no longer required from the plan for those own less than 5% of the business that employs them.  

These are some of the changes included in the SECURE Act, causing some retirees and financial advisers to feel optimistic about their financial futures. 

Which should investors choose: a 401(k) or an HSA? 

The entire discussion regarding these two retirement vehicles still begs the question, which then, should financial advisers or investors choose?  

Thankfully, in this case, they don’t have to choose one over the other – they can, and perhaps should, save using both.  

If your client needs easy access to savings to cover medical expenses, advise them to prioritize their HSA. Although their 401(k) will still allow for hardship withdrawals to pay for medical expenses, the withdrawal rules are much stricter and can come with a hefty income tax. 

Should your client be lucky enough to be in a position where they can maximize their retirement contributions, then they ought to invest in both plans. But should they only max out their HSA every year, this may be insufficient to fully fund their retirement. They can supplement this with a 401(k) which has higher contribution limits and no age limits for making contributions.  

In case only one is available to your client, advise them to choose the one offered by their employer, then sign up for the other account by themselves later, if possible. Not everyone can easily qualify for an HSA and not all employers offer the 401(k).  

The “rule of thumb” when investing in an HSA and/or a 401(k) is no longer set in stone, especially with the changes introduced by the SECURE Act. Consider these and other factors like your client’s retirement goals and needs when prescribing a retirement plan and a strategy for allocating funds to these accounts.  

For other articles on 401(k) and HSA accounts, visit and bookmark our Retirement page. It includes a wealth of resources to keep financial advisors updated on investment tools and strategies for retirement.