IRA to HSA Rollover

Are you missing out on a tax planning opportunity introduced in the Health Opportunity Patient Empowerment Act of 2006? This Act allows for a one-time penalty- and tax- free rollover of money from your traditional IRA to a health savings account (HSA). Technically, this is known as a “qualified HSA funding distribution.”

An HSA is a funding account for those with high-deductible health plans (HDHP). For 2021, HDHPs are defined as health insurance policies that have annual deductibles of at least $1,400 (individuals) and $2,800 (families), with maximum out-of-pocket limits of $7,000 (individuals) and $14,000 (families) per year. Out-of-pocket costs can include deductibles, copayment and coinsurance, but do not include premiums. The HSA is sometimes referred to as a medical IRA on steroids. Taxpayers can deduct the contribution to the HSA, but distributions, if made for qualified medical expenses, are free from any penalties or tax. Some utilize the account to fund current medical expenses. Others avoid distributions during their working years, so as to have an account they can tap into during their senior years when income streams are fixed so they can either reimburse themselves for medical expenses paid for during their working years or to pay for current medical expenses in their senior years. Keep in mind that it is crucial that receipts for these medical expenses be kept to support disbursements from the HSA.

Unfortunately, there are limitations to be aware of when executing this strategy.

1. The rollover from IRA to HSA can only be done once in a lifetime.
2. You have to be covered by an HDHP in order to make a rollover from your IRA to your HSA. Then you have to stay covered by an HDHP for at least 12 more months after the transfer. If not, the distribution from the IRA will be subject to the 10% penalty (unless you are 59½ or older) and to income tax.
3. The dollar limits for this rollover, for 2021, are:

• • $3,600 for individuals, with an additional $1,000 catch-up contribution if you’re age 55 or older.
  • $7,200 for family coverage, with the same $1,000 catch-up contribution if you’re age 55 or older.

The rollover is made via a direct trustee-to-trustee transfer. As such, the funds transferred from the IRA are not taxable, while funds placed into the HSA reduce the otherwise allowable annual HSA contribution amount.

This strategy allows you to just shift funds already in your traditional IRA to an HSA, without taking money from your non-retirement accounts. In addition, the transfer from the IRA will have removed some of the money, though a relatively small amount, out of the required minimum distribution (RMD) calculation.

Also, if you can avoid using the rolled-over funds until retirement, you’ll see a tax benefit. For example, if at age 55 you roll over the maximum of $8,200, assuming your HSA returns is 6% over ten years (until age 65), you’ll have $14,327 to spend on medical expenses, tax-free. If you had left the $8,200 in your IRA and got the same return, you would have just $10,889 after paying taxes (using an effective tax rate of, say, 24%).

Adding another layer of strategy above and beyond the direct rollover strategy previously discussed, if you’re 59½ or older, you could take a regular withdrawal from your IRA and then use it to contribute to your HSA. The income from the traditional IRA withdrawal and the tax deduction from the HSA contribution should be rendered tax neutral, while moving a total of nearly $50,000 over a six-year period (age 59½ to 64) out of traditional IRA, where they would have been, eventually, subject to RMD requirements, and into an HSA in which funds can be withdrawn, tax-free, at the taxpayer’s discretion if used for medical expenses.

By the way, the example directly above assumes you sign up for Medicare at age 65. You can contribute to your HSA as long as you are an eligible individual and have not enrolled in Medicare Part A, B, or D. Once you enroll in Medicare you may no longer contribute to your HSA. So, if you enroll in Medicare on July 21, you are no longer eligible to contribute to an HSA as of July 1. Your maximum contribution for that year would be for six months of that year (you were eligible the first six months of the year.) Remember to also include one half of the catch-up amount for that year.

If you turn age 65 and are still working and are not enrolled in Medicare, you are still eligible to contribute to your HSA.