Health Savings Accounts (HSAs) are an effective tool for account-holders to save for out-of-pocket medical expenses now and during retirement. Contributions made to HSAs are exempt from federal taxes and most state taxes, and distributions from HSAs for eligible health expenses are tax-free as well. Some account-holders may want to deposit more money into their HSA to increase their HSA accounts for health expenses, but they don’t have the means to make the contributions. The government allows a one-time transfer from an IRA to an HSA. This transfer can help account-holders accumulate more assets in their accounts and ultimately save on taxes.
If an HSA account holder is considering transferring funds from an IRA to an HSA, there are several rules and restrictions that the account holder needs to understand. A qualified HSA funding distribution (QHFD) allows for the transfer of funds from an IRA to an HSA. The rollover is tax-free. Moving funds from an IRA to an HSA may have more tax advantages than saving in an IRA alone.
The QHFD is a once-in-a-lifetime direct trustee-to-trustee transfer of an IRA to an HSA. The account holder must own both the HSA and the IRA to make the transfer, except when an inherited IRA is involved. For example, a spouse cannot transfer their IRA into the other spouse’s HSA. Amounts transferred are not included as taxable income, and the transferred amount cannot be deducted when filing tax returns. The only exception to the one-time transfer rule is if the account holder changes from self-only coverage to family coverage during the same year the transfer takes place.
The individual must be an HSA-eligible individual to transfer money from an IRA – meaning the individual must be enrolled in a High Deductible Health Plan (HDHP). The account holder must not be ineligible for an HSA for other reasons, e.g., enrolled in any part of Medicare.
Also, the individual must remain eligible for the HSA for at least 12 months after the transfer. If the account holder has an existing HSA but is not enrolled in an HDHP, the QFHD is prohibited because HSA contributions are not allowed. Also, if funds are transferred, and then the account holder loses HDHP eligibility before 12 months from the transfer, the QFHD will be taxable and is subject to an additional 10% tax. Taxes do not apply in cases of death or disability of an HSA-eligible individual.
ANNUAL CONTRIBUTION LIMIT
The IRS imposes a maximum on the total contributions to an HSA, which includes any transfer from an IRA. The 2022 maximum HSA contribution limits are:
|Self-only HSA maximum contribution limit||$3,650|
|Family HSA maximum contribution limit||$7,300|
|HSA catch-up contribution for individuals age 55 or older||$1,000|
A qualified HSA funding distribution relates to the taxable year in which the IRA transfer is made. Account-holders can contribute to an HSA for a tax year by depositing an HSA contribution no later than April 15 of the following year. Even so, the IRA transfer counts towards the contribution limit in the year it is transferred, even if transferred between January 1 and April 15.
Example 1 – Individual A is under age 55 and has a family HDHP. A $2,000 contribution is made in 2022. A one-time transfer from an IRA is allowed, but the maximum amount eligible for transfer is $5,300. This is because the annual limit for HSA contributions in 2022 for this individual is $7,300. If Individual A’s employer contributes to the HSA, that contribution amount also needs to be subtracted from the total coming over from the IRA. However, if the account holder is age 55 or older, the HSA contribution limit is $8,300 (due to catch-up allowance). HSA-eligible individuals must subtract any personal HSA contributions and any employer contributions to determine the maximum IRA transfer amount.
Example 2 – Individual B is under age 55 and has self-only coverage. The maximum HSA contribution is $3,650. No employee or employer contributions have been made to the HSA in 2022, so a transfer of $3,650 from Individual B’s IRA to the HSA takes place on June 1, 2022. On August 1, 2022, Individual B enrolls in family HDHP coverage, so the HSA contribution limit increases to $7,300. In this example, an additional $3650 may be transferred from the IRA to the HSA by December 31, 2022. This case is the only exception to the once-in-a-lifetime transfer rule as noted above.
TRADITIONAL IRA VERSUS ROTH IRA
The transfer into the HSA can come from a traditional IRA, Roth IRA, inactive SEP, or inactive Simple IRA. If an account holder has multiple types of IRAs, the taxation of IRA accounts can get complicated, so those considering this transfer should speak with a tax advisor to help determine which type of IRA to transfer.
- Traditional IRA – distributions from traditional IRAs are usually subject to taxation. Account-holders can save tax dollars when money is transferred from a traditional IRA to an HSA, as distributions from the HSA are not taxed for eligible HSA expenses.
- Roth IRAs – contributions to a Roth IRA are taxable to the account holder but can be withdrawn tax-free at any time. HSA-eligible individuals could withdraw their Roth contributions from their Roth IRA and contribute them to their HSA rather than making a trustee-to-trustee transfer. However, earnings that accumulate from investments in a Roth IRA have not been taxed and may be subject to tax when withdrawn. The beauty of a Roth IRA is that when certain requirements are met, earnings are not taxed, either. Generally, to avoid taxation on Roth IRA earnings, the account holder must be age 59 ½ and the Roth IRA must have existed for at least five years. There are other exceptions, as well. Some account-holders may want to keep their funds in a Roth IRA instead of making a transfer to an HSA because Roth IRA distributions may not be taxed in the future and distributions can be made for any reason, not just to pay medical expenses. That said, any transferred money, including earnings, from a Roth IRA will not be taxable to the account holder when withdrawn from the HSA to pay for eligible medical expenses.
Because only one IRA-to-HSA transfer is allowed, account-holders with multiple small-balance IRAs should transfer money from IRA to IRA (if possible) to combine them first, then make one transfer to the HSA.
HSA-eligible individuals seeking to increase the money in their HSA accounts and save taxes on money that ordinarily would be taxed at some time in the future may benefit from this one-time transfer. Account-holders considering this option must also anticipate that they will be eligible for an HSA for at least a year after the transfer. As suggested above, anyone considering this option should seek advice from a tax professional before making a transfer.
TRI-AD and our Associates’ suggestions or recommendations shall not constitute legal advice. No content on our website can be construed as tax or legal advice and TRI-AD may not be considered your legal counsel or tax advisor. Clients are encouraged to consult with their tax advisor and/or attorney to determine their legal rights, responsibilities, and liabilities. This includes the interpretation of any statute or regulation, federal, state, or local; and/or its application to the clients’ business activities.