Did you know that you can make a one-time, penalty- and tax-free rollover of money from your IRA to a health savings account (HSA)? The process is officially known as a qualified HSA funding distribution, and it was made possible by the Health Opportunity Patient Empowerment Act, back in 2006.
- You can make a one-time distribution of money from your IRA into a health savings account (HSA).
- A “testing period” requires you to remain eligible for the HSA for at least 12 months following the rollover.
- To be eligible for an HSA, you must be enrolled in a high-deductible health plan (HDHP).
- Rolling over from a traditional IRA, instead of a Roth, typically offers the better tax benefit.
What Is a Health Savings Account (HSA)?
An HSA is designed for people with high-deductible health plans (HDHPs). Those are health insurance policies that have annual deductibles of at least $1,350 for individuals and $2,700 for family coverage (as of 2019).
Also, the plan’s maximum out-of-pocket limit must be less than $6,750 a year for individuals and $13,500 for family coverage. Premiums don’t count as out-of-pocket costs, but deductibles, copayments, and coinsurance do.
For 2020, those limits will increase to annual deductibles of at least $1,400 for individuals and $2,800 for families. Maximum out-of-pocket costs will top out at $6,900 and $13,800, respectively.
You contribute to an HSA using pre-tax funds, which reduces your taxable income. You can then withdraw money from your HSA tax-free if you use it for qualified medical expenses. If you’re 64 or younger, you’ll owe taxes and a 20% penalty if you use funds for nonmedical reasons. However, after age 65 (or if you have a disability at any age), withdrawals for nonmedical reasons don’t incur the penalty, although they're still taxed at your current tax rate.
You can keep your HSA funds in the account to use later in life, such as after you retire. The account—and all the money in it—belongs to you, even if you change health insurance plans, switch jobs, or retire.
You can only make one IRA-to-HSA rollover during your lifetime.
IRA-to-HSA Rollover Rules
You can move funds from an IRA to an HSA only if you’re eligible to make contributions to your HSA. In other words, you need to do the transfer while you’re covered by a high-deductible health plan and otherwise eligible to have an HSA.
What’s more, the IRA-to-HSA rollover includes a “testing period” that requires you to remain eligible for your HSA for 12 months following the transfer. This means you must stay in your HDHP at least until the testing period expires. If you don’t remain eligible (for example, you switch to a non-HDHP), you’ll have to include the money you rolled over as income when you file your taxes. In addition, the amount will be subject to a 10% penalty.
You can only roll over funds from an IRA to an HSA once during your lifetime. The maximum amount you can roll over is the same as your annual HSA contribution limit for that year. For 2019, the limits are:
- $3,500 for individuals, with an additional $1,000 catch-up contribution if you’re age 55 or older. (For 2020, that rises to $3,550, with a $1,000 catch-up contribution.)
- $7,000 for family coverage, with the same $1,000 catch-up contribution. (For 2020, that rises to $7,100, and the $1,000 catch-up contribution remains unchanged.)
Finally, HSAs and IRAs are individual accounts. There’s no such thing as a joint IRA or a joint HSA. This means that if you're married, you and your spouse can each roll over funds from your respective IRAs to your own HSAs—but not to each other’s.
You can, however, pay healthcare expenses for each other (and other family members) out of either account.
Traditional IRAs Benefit More
Technically, you can do a rollover from either a traditional IRA or a Roth IRA to an HSA. However, it’s more advantageous to roll over from a traditional IRA. That’s because withdrawals of contributions from a Roth IRA are already tax- and penalty-free anytime, and you can withdraw earnings tax-free after age 59½.
A rollover from a traditional IRA to an HSA allows you to “fill” your HSA immediately to pay for medical expenses tax-free. Any nondeductible IRA contributions you may have made are not eligible for the rollover, so they will remain in your IRA.
Provided you can avoid using the rolled-over funds until retirement, you’ll see a tax benefit. Let’s say, for example, that at age 55 in 2019, you roll over the maximum of $8,000. Assuming your HSA returns 6% over 10 years (until age 65), at that time you’ll have $14,327 to spend on medical expenses, tax-free.
If you had left the $8,000 in your IRA and got the same return, you would have just $10,889 after paying taxes (at a 24% marginal rate).
HSA Rollovers from a Different Account
To roll over funds from other types of retirement accounts, such as a 401(k) or 457 plan, you must first roll those funds into an IRA. Once the funds are in an IRA you can make your one-time, tax-free transfer into your HSA. This type of move is tricky and should be done with the help of a professional financial advisor.
Other Ways to Fund an HSA
If you can afford to contribute to both your HSA and a traditional IRA, you’ll lower your adjusted gross income (AGI) and reduce your taxes. And your IRA will continue to grow for retirement.
If money is tight and you’re 59½ or older, you could take a regular withdrawal from your IRA and use it to contribute to your HSA. The tax bite from the traditional IRA withdrawal and the tax deduction from the HSA contribution should nearly cancel each other out.
Most important, you can do this more than once—in fact, every year if you want.