Transferring IRA money to an HSA

Originally posted on The Bahrat Express News

Did you know that you can make a one-time, penalty- and tax-free money transfer from your Individual Retirement Account (IRA) to a Health Savings Account (HSA)? The process is officially known as a Qualified HSA Funding Distribution and was made possible by the Health Opportunity Patient Empowerment Act in 2006.

Key learning points

  • HSAs have out-of-pocket expenses and annual contribution limits, and you must be enrolled in a high-deductible health plan to qualify.

  • You can make a one-time distribution of money from your IRA into a health savings account.

  • A trial period requires you to remain eligible for the HSA for at least 12 months after rollover.

  • You must first roll money into an IRA before moving it from another type of retirement account, such as a 401(k) or 457 plan, to an HSA.

  • Contributing to both an HSA and a traditional IRA will lower your adjusted gross income and lower your taxes.

What is a Health Savings Account (HSA)?

An HSA is designed for people with high deductibles (HDHPs). These are health insurance plans with annual deductibles of at least $1,500 for individuals and $3,000 for family coverage for 2023 (down from $1,400 and $2,800 in 2022).

Here are a few key figures to know about the HSA:

  • The annual maximum cash outlay must be less than $7,500 for individuals in 2023 (down from $7,050 in 2022) and $15,000 for families ($14,100 in 2022).

  • The annual contribution limit for individuals is $3,850 for 2023 ($3,650 for 2022) and $7,750 for families ($7,300 for 2022).

Remember, your premiums don’t count as an out-of-pocket expense, but deductibles, co-payments, and coinsurance do.

You contribute to an HSA with pre-tax resources, which reduces your taxable income. You can then withdraw tax-free money from your HSA if you use it for qualified medical expenses. However, if you are 64 or younger, you will owe taxes and a 20% penalty if you use money for non-medical reasons. Withdrawals for non-medical reasons do not incur a penalty after you turn 65 or if you have a disability at any age, although they will still be taxed at your current tax rate.

You can keep your HSA money in the account to use later in life, such as after you retire. The account (and all the money in it) is yours, even if you change health plans, change jobs, or retire.

You can only switch from an IRA to an HSA once in your lifetime.

IRA-to-HSA Rollover Rules

You can only move money from an IRA to an HSA if you are eligible to contribute to your HSA. In other words, you must make the transfer while covered by an HDHP and otherwise qualified to have an HSA.

In addition, the IRA-to-HSA rollover includes a trial period where you must remain eligible for your HSA for 12 months after the transfer. This means that you should at least stay in your HDHP until the test period ends. If you remain ineligible (for example, you switch to a non-HDHP), you must include the money you rolled over as income when you file your tax return. In addition, the amount will be subject to a 10% penalty.

You can only roll money from an IRA to an HSA once in your lifetime. The maximum amount you can roll over is equal to your annual HSA contribution limit for that year.

The limits for 2023 are as follows:

  • $3,850 ($3,650 in 2022) for individuals, with an additional $1,000 catch-up fee if you are 55 or older.

  • $7,750 ($7,300 in 2022) for family coverage, with the same $1,000 catch-up fee.

Keep in mind that HSAs and IRAs are individual accounts. There is no such thing as a joint IRA or a joint HSA. This means that you and your spouse can transfer any money from your respective IRAs to your own HSAs, but not to each other’s HSAs if you’re married. But you can cover healthcare costs for each other and other family members from both accounts.

Switching to an HSA from a traditional IRA — rather than a Roth — usually offers a better tax break.

Rollovers from other accounts

Traditional IRAs

You can switch from a traditional or a Roth IRA to an HSA. However, it is more beneficial to roll from a traditional IRA as this account gives you more benefits. That’s because withdrawals of contributions from a Roth IRA are already tax- and penalty-free at any time, and you can withdraw income tax-free after age 59½.

With a rollover from a traditional IRA to an HSA, you can immediately load your HSA to pay for medical expenses tax-free. Any non-deductible IRA contributions you make are not eligible for the rollover, so they remain in your IRA.

You’ll see a tax break provided you don’t have to use the rolled-over money until retirement. Let’s say you cross the $8,000 maximum when you turn 55. Assuming your HSA yields a 6% return over ten years (until age 65), at that point you have $14,327 to spend on medical expenses, tax-free. But if you left the $8,000 in your IRA and got the same return, you’d only have $10,889 after paying taxes (at a marginal rate of 24%).

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