Did you know you can make a one-time, penalty- and tax-free rollover of money from your individual retirement account (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 in 2006.
- HSAs come with out-of-pocket expenses and annual contribution limits, and you must be enrolled in a high-deductible health plan to be eligible for one.
- You can make a one-time distribution of money from your IRA into a health savings account.
- A testing period requires you to remain eligible for the HSA for at least 12 months after the rollover.
- You must first roll funds into an IRA before moving them from another type of retirement account, such as a 401(k) or a 457 plan, to an HSA.
- Contributing to both an HSA and a traditional IRA will lower your adjusted gross income and reduce your taxes.
What Is a Health Savings Account (HSA)?
An HSA is designed for people with high-deductible health plans (HDHPs). These are health insurance policies with annual deductibles of at least $1,400 for individuals and $2,800 for family coverage for 2021 and 2022.
Here are a few key figures you need to know about the HSA:
- The annual maximum out-of-pocket expense must be less than $7,000 for individuals in 2021 and $7,050 in 2022 ($14,000 and $14,100, respectively, for family coverage).
- The annual contribution limit is $3,600 and $3,650 for individuals for 2021 and 2022, respectively ($7,200 and $7,300 for families)
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. Withdrawals for nonmedical reasons don't incur the penalty after you turn 65 or if you have a disability at any age, 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 rollover from an IRA to an HSA during your lifetime.
IRA-to-HSA Rollover Rules
You can move funds from an IRA to an HSA only if you're eligible to contribute to your HSA. In other words, you need to do the transfer while you're covered by an HDHP and are 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 need 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 funds from an IRA to an HSA once during your lifetime. The maximum amount you can rollover is the same as your annual HSA contribution limit for that year.
The limits for 2021 and 2022 (respectively) are as follows:
- $3,600 and $3,650 for individuals, with an additional $1,000 catch-up contribution if you're age 55 or older.
- $7,200 and $7,300 for family coverage, with the same $1,000 catch-up contribution.
Keep in mind that HSAs and IRAs are individual accounts. There's no such thing as a joint IRA or a joint HSA. This means that you and your spouse can each roll funds over from your respective IRAs to your own HSAs but not to each other's HSAs if you're married. But you can cover health care expenses for each other and other family members out of either account.
Rolling into an HSA from a traditional IRA—instead of a Roth—typically offers a better tax benefit.
Rollovers From Other Accounts
You can do a rollover from either a traditional or a Roth IRA to an HSA. However, it's more advantageous to roll from a traditional IRA as this account offers 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 earnings tax-free after age 59½.
A rollover from a traditional IRA to an HSA allows you to load your HSA immediately to pay for medical expenses on a tax-free basis. Any nondeductible IRA contributions you make are not eligible for the rollover, so they will remain in your IRA.
You'll see a tax benefit provided you can avoid using the rolled-over funds until retirement. Let's say that you roll over the maximum of $8,000 when you turn 55. Assuming your HSA returns 6% over ten years (until age 65), at that time, you'll 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 would have just $10,889 after paying taxes (at a 24% marginal rate).
401(k) and 457 Plans
You may also be able to fund your HSA by rolling over money from other types of retirement accounts, such as a 401(k) or 457 plan. To roll the funds over from other retirement accounts, 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. And most importantly, you can do this more than once—in fact, every year if you want.