A Fully Funding 401(k) vs. Roth IRA vs. HSA

Using qualified plans helps save a wad of cash on your taxes.

Using qualified plans helps save a wad of cash on your taxes.

So many accounts to contribute to, but only so much income. Some of the most important financial decisions you make in your 20s and 30s are about what accounts to fully fund each year. Knowing the different retirement and medical savings plans helps you decide which ones are right for you.

Eligibility

Not everyone can contribute to these plans. To contribute to a 401(k) plan, you need to work at a company that offers such a plan. To contribute to a Roth IRA, you've got to have earned income and your total income has to be below the annual limits, based on your filing status. To contribute to a health savings account, you need to be covered by a high-deductible health plan. An HDHP must have a minimum deductible and a maximum deductible for out-of-pocket expenses. The amounts change each year and differ depending on whether you have individual or family coverage.

Tax Treatment of Contributions

Contributions to both 401(k) plans and HSAs are pretax contributions, which means each dollar you contribute to the accounts reduces your taxable income. Roth IRAs, on the other hand, don't reduce your taxable income for the year that you make the contributions. Your 401(k) contributions, though not taxable, don't get deducted on your income taxes because they're not included in your taxable income on your W-2. For example, assume your salary is $71,500 and you contribute $16,500 to your 401(k) plan. In such a case, your W-2 would show only $55,000 of taxable income. When you make contributions to a Roth IRA, you don't report the contributions on your tax return because they aren't deductible. When you contribute to an HSA, you do report the contributions on your tax return as an adjustment to income.

Distributions

These accounts have significant rewards for qualified distributions and large penalties for non-qualified distributions. Distributions from your HSA are totally tax-free as long as you use the money for qualified medical expenses. If you don't, the whole distribution is taxable and subject to an extra 20 percent tax. Similarly, Roth IRA distributions are tax-free if you are at least 59 1/2 years old and have had the account open for five years. If you don't meet the requirements, you can remove the contributions tax-free, but once you've exhausted those, the earnings are taxed and hit with a 10 percent penalty. Finally, all 401(k) plan distributions are taxable (you got a tax break for the contributions, remember?). If you take a distribution before age 59 1/2, you also have to pay a 10 percent penalty.

Contribution Limits

The contribution limits vary widely between the three plans and they adjust annually for inflation. As of 2012, you can contribute up to $3,100 for a single HSA and up to $6,250 for a family HSA. Roth IRAs allow a maximum contribution of $5,000, but this limit is cumulative with traditional IRAs. 401(k) plan contributions have two sets of limits: your contributions are limited to $17,000, and your contributions plus your employer's contributions are limited to $50,000.

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