HSA vs. 401(k): Which Is the Better Investment Option?

Saving for the future is a priority for many, but navigating different investment options can be confusing. Health Savings Accounts (HSAs) and 401(k) plans both offer tax advantages but serve different purposes. Understanding their differences in contributions, tax benefits, withdrawal rules, and employer support can help determine which aligns with your financial goals.

Eligibility Criteria

HSAs are available only to individuals enrolled in a high-deductible health plan (HDHP). In 2024, an HDHP must have a minimum deductible of $1,600 for self-only coverage or $3,200 for family coverage. Those enrolled in Medicare or claimed as a dependent on another tax return cannot contribute.

401(k) plans are employer-sponsored, so eligibility depends on whether an employer offers one. The SECURE 2.0 Act of 2022 expanded access by requiring employers to allow long-term, part-time employees to participate after two consecutive years with at least 500 hours worked annually. Employers may also impose additional requirements, such as a minimum age of 21 or a waiting period before new hires can enroll.

Contribution Limits

Annual contribution limits are adjusted periodically for inflation. In 2024, individuals can contribute up to $4,150 to an HSA, while those with family coverage can contribute up to $8,300. People aged 55 and older can add an extra $1,000. These limits include both personal and employer contributions.

A 401(k) allows for higher contributions. In 2024, employees can contribute up to $23,000, with those aged 50 and older eligible for an additional $7,500 catch-up contribution, bringing their total to $30,500. Employers may also contribute through matching or profit-sharing, with total combined contributions capped at $69,000 for those under 50 and $76,500 for those eligible for catch-up contributions.

HSA contributions are lower, limiting how quickly funds accumulate. However, unlike a 401(k), HSA funds never expire and remain available regardless of employment status.

Tax Considerations

Both accounts offer tax advantages but differ in how they reduce taxable income, grow, and are taxed upon withdrawal.

HSA contributions are tax-deductible, lowering taxable income in the year they are made. Contributions made through payroll deductions are also exempt from Social Security and Medicare taxes, providing additional savings. HSA funds grow tax-free, and withdrawals for qualified medical expenses are not taxed, offering a triple tax advantage.

A 401(k) also lowers taxable income, but contributions are only exempt from federal and most state income taxes, not Social Security and Medicare taxes. The money grows tax-deferred, meaning investment gains, dividends, and interest are not taxed annually. Taxes are owed upon withdrawal, typically in retirement, at the account holder’s ordinary income tax rate.

Qualified Withdrawals

HSAs allow tax-free withdrawals for qualified medical expenses, including doctor visits, prescriptions, and some long-term care costs. There is no time limit on reimbursing oneself for medical expenses incurred after the HSA was established, as long as proper documentation is maintained.

A 401(k) is primarily for retirement, with penalty-free withdrawals allowed starting at age 59½. Hardship withdrawals are permitted under strict IRS guidelines, and some plans offer loans that must be repaid with interest. Required minimum distributions (RMDs) begin at age 73, requiring account holders to withdraw a calculated amount annually.

Penalties for Unqualified Withdrawals

HSA withdrawals for non-medical expenses are subject to income tax and a 20% penalty if taken before age 65. After 65, non-medical withdrawals are taxed as ordinary income but are no longer penalized.

A 401(k) imposes a 10% early withdrawal penalty on distributions taken before age 59½ unless an exception applies, such as total and permanent disability or medical expenses exceeding 7.5% of adjusted gross income. Some plans allow penalty-free withdrawals through substantially equal periodic payments (SEPP), which must follow an IRS-approved schedule. Unlike HSAs, 401(k) withdrawals remain taxable as ordinary income regardless of age.

Employer Support

Employers can contribute to both HSAs and 401(k)s, but the structure and availability differ.

Many employers contribute to HSAs through direct deposits or matching employee contributions. These contributions count toward the annual HSA limit but are not subject to income tax. Some companies provide seed money at the beginning of the year to help cover initial medical costs, while others match contributions throughout the year. HSA funds belong to the employee immediately and are not subject to vesting schedules.

401(k) plans often include employer matching contributions, which can significantly boost retirement savings. A common structure is a dollar-for-dollar match up to a percentage of salary, such as 100% of the first 3% contributed by the employee and 50% of the next 2%. Some employers also provide non-elective contributions, meaning they contribute regardless of whether the employee does. These contributions may be subject to a vesting schedule, requiring employees to remain with the company for a set period before gaining full ownership. Unlike HSA contributions, employer 401(k) contributions do not count toward the employee’s individual contribution limit, allowing for higher total savings potential.