IRA vs. 401(k) vs. HSA: Which Is the Best Way to Save for Retirement?

June 05--When it comes to saving for retirement, most Americans have a few main options. The most widely available are traditional and Roth IRAs, although more people choose their employer's retirement plans such as 401(k)s and 403(b)s. There's also the health savings account (HSA), which isn't commonly thought of as a retirement account, but definitely deserves to be part of the discussion.

With that in mind, here's a rundown of the key advantages (and disadvantages) of these types of retirement accounts, so you can make an informed decision for your own retirement strategy.

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Benefits of an IRA

Let's start with the individual retirement arrangement (IRA), as it's the only one of the three retirement savings options open to virtually all American workers. To be clear, there are income limitations for the traditional IRA deduction if you are eligible for an employer's plan, and high-income individuals may need to use a backdoor method of contributing to a Roth IRA. But workers can generally find a way to contribute to an IRA in one way or another.

There are a few key advantages to investing in an IRA instead of a 401(k) or similar plan. For starters, there are a wide variety of investments you can choose from. The typical 401(k) plan offers about 20 investment options, but with an IRA, you can invest in virtually any stocks, bonds, or funds you want.

In addition, there are a couple of popular early withdrawal provisions that only apply to IRAs. Specifically, you can use your IRA funds before reaching the normal withdrawal age (59 1/2) for college expenses, and you can also withdraw as much as $10,000 at any time to use toward a first-time home purchase.

Disadvantages of IRAs include the relatively low contribution limit and the lack of loan availability. As we'll see in the next section, the $5,500 annual contribution limit and $1,000 catch-up contribution provision for savers age 50 and older are significantly less than what 401(k) and other qualified plans allow. And while you may be able to borrow money from your 401(k), there's no such thing as an IRA loan.

There are also some advantages associated specifically with Roth IRAs that are important to mention. First, with a Roth IRA, you are free to withdraw your original contributions at any time, and for any reason. This makes a Roth IRA an appealing option for people who don't necessarily want their money tied up for decades. In addition, Roth IRAs have no required minimum distributions as you get older, and you can keep contributing to a Roth IRA no matter how old you are, as long as you have earned income.

Why a 401(k) could be better for you

If your employer offers a 401(k) or other qualified retirement plan, and you qualify for an IRA based on your income, you can choose the best option for you. There are a few key advantages to 401(k) investing you should consider.

First, 401(k)s and similar plans have rather high contribution limits. Employees can choose to defer as much as $18,500 of their compensation into their account during 2018, which is more than three times the IRA limit. The catch-up provision for savers age 50 and older is also far more generous, allowing for an additional $6,000 in contributions.

Second, and most significantly, 401(k) and 403(b) plans often have employer-matching contributions. Typically, the employer sponsoring the plan will match your contributions up to a certain percentage of your compensation -- say, 5%.

If your employer offers matching contributions, it rarely makes sense to not contribute at least enough to your plan to take full advantage. Not doing so is literally turning down free money.

Finally, although your plan isn't required to offer loans, most 401(k)s allow participants to borrow money from their accounts. The debate over whether 401(k) loans are good or bad is another issue for another article; the point is, this is a feature IRAs simply don't have.

Is the HSA the best retirement saving option of all?

Although HSAs aren't generally thought of as retirement accounts, they should be.

If you aren't familiar, the HSA is a type of account designed to allow individuals with high-deductible health plans (as defined by the IRS) to save for medical expenses. Contributions are made on a tax-deferred basis (similar to a traditional IRA), up to the annual limit -- for 2018, these are $3,450 if you have individual health coverage or $6,850 if you have a family health plan. And just to be perfectly clear, if you don't have a high-deductible health plan, you aren't eligible to contribute.

Once money is contributed to your HSA, you have a variety of investment options, similar to a 401(k). Your money is then allowed to grow and compound on a tax-deferred basis.

The HSA is unique because of the additional benefit of tax-free withdrawals for qualified medical expenses. The HSA is the only type of account that has this double tax benefit: deductible contributions and some tax-free withdrawals. And once the account owner turns 65, the money can be withdrawn for any reason (although not tax-free), making it a smart retirement savings option as well.

According to Fidelity, the average 65-year-old couple will spend $275,000 on out-of-pocket healthcare expenses throughout their retirement. The HSA can allow you to save for this burden while simultaneously taking advantage of immediate and future tax breaks.

Breaking down the key advantages

I know that's a lot to digest, so here's a rundown of the main advantages of each account type:

All IRAs

Traditional IRA

Roth IRA

401(k)/403(b)/457

HSA

Wide variety of investments to choose from.

Immediate tax deduction for qualified individuals.

Ability to withdraw contributions at any time.

High contribution limits (up to $18,500 for 2018).

Tax deduction for contributions.

Early withdrawals to pay for college expenses.

No RMD.*

May qualify for employer matching contributions.

Tax-free withdrawals for qualified medical expenses.

Early withdrawals for a first-time home purchase (up to $10,000).

No maximum contribution age (with earned income).

Better catch-up provision than IRA.

Withdrawals for any reason after age 65.

Tax-free withdrawals.

Ability to borrow from your retirement savings.

No RMD.

Data source: Author. *Required minimum distributions.

You don't necessarily have to choose just one

As a final thought, the best retirement savings option for you can be a combination of these. For example, if you want to save $10,000 this year toward your retirement, it's perfectly reasonable to put $5,000 into your 401(k) to take full advantage of your employer's matching program, $3,000 into your HSA to take advantage of the unique tax benefits, and $2,000 into a Roth IRA because you may or may not need to use some of your retirement savings to pay for your child's college education.

The bottom line is that everyone's situation is different. You should weigh the pros and cons of each option to determine the best retirement saving strategy for you.

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