It’s That Time of YearPosted: November 6, 2017
From the number of discussions I’ve been having with my staff and my own children, I have come to realize that savings methods CPAs think of as second nature aren’t second nature to many people out there. My discussions this year have focused on traditional versus Roth 401(k) contributions, HSA versus FSA contributions, and HSA versus 401(k) contributions.
Let’s start with the last item first. My advice is always to contribute enough to your 401(k) to get all the company match you are entitled to (if one is provided) before considering an HSA contribution. Not taking advantage of the match is like giving an employer a discount for your services. They’re willing to pay you more, but you say, nah, I’ll do the work for less than you are willing to pay me. I have one word for that: Stupid! Once you get the full 401(k) match, however, the answer on which to contribute to moves decidedly in favor of the HSA. While the traditional 401(k) includes a tax benefit for the initial contribution, and taxes are deferred on investment earnings, you do have to eventually pay taxes when the money is withdrawn (which is required by law after a certain age). The Roth 401(k) has the benefit of never paying taxes on investment earnings even upon withdrawal, but you don’t get a tax benefit against your current taxes for the amounts contributed currently. The HSA combines all three benefits – a current tax benefit for contributions, deferral of taxes on earnings, and no taxes on amounts withdrawn as long as they are used for medical expenses. With the way medical expenses are going, young people today will need all the money they can get for those costs when they grow old. The HSA has two added benefits – if you have a medical emergency before you retire and need to get to the money, you can withdraw it to pay those costs with no penalties; and if you need the money in retirement, you can withdrawal it and just pay taxes on the withdrawn amount like a traditional 401(k). That is a deal you don’t see every day from our government.
The HSA versus FSA decision usually is hands down in favor of the HSA because of the ability to carryover the HSA balance from one year to the next; but there are two situations where the FSA should get serious consideration. The most obvious is if you are not eligible for an HSA contribution. In order to contribute to an HSA, you must be covered by a high deductible health plan ($1,300 for an individual or $2,600 for a family). If you are covered by an HMO or a low deductible plan, then an FSA is your only option. The second circumstance is if you need access to the money early in the year and don’t have other financial means to cover the expense. An FSA allows you to get the entire amount you plan to put in the account on the first day of the year, while an HSA only allows you to get at the money already in the account.
The last topic is whether to make contributions to a traditional 401(k) or a Roth 401(k). Generally speaking, the younger you are the more a Roth makes sense, but there a lot of questions to consider. Will your tax rate at retirement be higher or lower than your current tax rate? Can you afford to put enough into the plan to get the full company match without the reduced taxes afforded by the traditional 401(k) contribution? And do you believe the tax structure (primarily an income tax) will be the same when you retire as it is today? Because I can’t predict the future, and don’t trust the government to keep their paws off my money, my advice is hedge your bets. If possible, put half in a traditional and half in a Roth 401(k). Whatever happens you got the answer half right and are better off than if you had picked the wrong one; but if you think you can predict the future, go for whatever fits your expected outcome better.
There is a lot more that can be said on this subject, but that would make this blog into a term paper and we don’t want to do that. And because people think they can sue over anything, please note that all the above advice is based on laws at the time of the writing of this blog and is worth what you paid for it – nothing. Any decisions you make about contributions to any of the above plans is a personal decision you, or you and your financial advisor should make based on your specific situation.