How to Fund Your HSA with IRA Dollars

Whoever said, “There’s no such thing as a free lunch” was unaware of how often I eat out at my friends’ expense. Of course, I understand that someone has to pay for the lunch; I just know that it’s usually not me.

From a financial planning perspective, a “free lunch” might relate to the relatively unknown one-time IRA to HSA transfer. This rule allows an individual to transfer some of his or her tax-deferred IRA dollars to a high-deductible savings account. If prepared properly, those tax-deferred dollars that would be taxable upon withdrawal in the future can be turned into tax-free dollars if withdrawn from an HSA for qualified medical expenses. (For related reading, see: HSA vs. FSA: Navigating the Alphabet Soup.)

The IRA to HSA transfer allows individuals and families to make a one-time only transfer from their traditional IRA (sometimes a SIMPLE and SEP IRA too) to their HSA without adverse tax consequences. The caveat? Only those who are eligible for a high-deductible healthcare plan can participate. (For related reading, see: Why You Should Have a Roth IRA.

The transfer is only allowed one time, and individuals and families cannot contribute more than the applicable HSA federal limit: $3,250 for individuals and $6,450 for families as of 2013. There is an additional catch-up allowance for those between the ages of 55 and 65. Another catch: If you currently fund your HSA with pre-tax dollars from wages earned, the dollar amount transferred from the IRA to the HSA can only be up to the federal limit, including the year-to-date contributions already made.

IRA to HSA transfers are not tax-deductible as an HSA contribution. Also, upon transferring, the dollars are not taxable and are exempt from the 10% early withdrawal penalty. This is true only if the IRA dollars are moved to the HSA via a direct transfer. A direct transfer means that the IRA dollars are not paid to the IRA owner. Instead, they are sent directly to the HSA provider.

Everyone would like to get as many free lunches as I do, but this particular free lunch is best for the following individuals who already have an IRA and HSA:

  • Those close to retirement who are looking for a way to fund their HSA for future medical expenses
  • Those looking to reduce their future required minimum distributions
  • Those who would like a free lunch

Although the amount of the transfer is relatively small, I would never turn down a free lunch just because it wasn’t large enough. Enjoy your meal.
It’s important to talk with a tax professional before making an IRA to HSA transfer. For more information on the IRA to HSA transfer rules, see this HSA worksheet. (For related reading, see: Why Playing It Safe Could Hurt Your Retirement.)