Your IRA Can Help Fund Your HSA
Health savings accounts (HSAs) are perhaps the best retirement planning tool available. Most people aren’t aware that if you’re looking for cash to fully fund the year’s HSA contribution, a transfer from an IRA might do the job.
An HSA has three powerful tax benefits. Contributions to the account are tax deductible, or excluded from gross income when an employer makes them. The account can be invested, and income and gains compound tax free in the account. When distributions are taken from the account to pay for qualified medical expenses, the distributions are tax free.
The annual contribution limit for an HSA in 2019 is $3,500 if you have individual health insurance coverage and $7,000 if you have family coverage. For people age 55 and older, an additional $1,000 catch-up contribution is allowed. You can make the contribution, or an employer can contribute to your account. You must have a qualifying high-deductible medical insurance policy. The deductible for individual coverage must be at least $1,350 and for family coverage the deductible must be $2,700.
When you’re fully or partially funding the HSA, a possible source of cash for contributions is your IRA using a qualified HSA funding distribution (QHFD).
In a QHFD, an individual has funds transferred (or rolled over) from an IRA to an HSA. The rollover, combined with any other contributions to the account during the year, can’t exceed the year’s contribution limit. The rollover is tax free, allowing you to move funds from your IRA to the HSA, which has even better tax benefits than the IRA.
The QHFD is a one-time only rollover. It’s allowed once-in-a-lifetime limit per taxpayer, not per IRA. So, if you have multiple IRAs, you still can do only one QHFD during your lifetime. If one IRA doesn’t have enough funds to transfer as much as you want, you first need to transfer enough funds from one IRA to another so that one IRA has enough funds. Then, you do one QHFD from one IRA.
A QHFD must be a direct trustee-to-trustee rollover. You can’t take a distribution and transfer it to the HSA yourself without the distribution being taxable.
The QHFD can come from either a traditional IRA or Roth IRA or from an inactive SEP or Simple IRA. There’s no 10 percent early distribution penalty if you’re under age 59½.
Only pre-tax money can be transferred in a QHFD, which limits the amount that can be transferred from a Roth IRA to any accumulated investment income. If you have nondeductible contributions in an IRA, they can’t be transferred to the HSA. The good news is the pro-rata rules don’t apply to QHFD. Under the pro-rata rules, whenever you have a distribution or rollover from an IRA that has nondeductible contributions, a portion of the transaction is considered to include a pro rata portion of the nondeductible contributions. You can’t transfer or distribute only the pre-tax money. The QHFD, however, is an exception; you transfer only the pre-tax money and leave the after-tax money in the IRA.
Inherited IRA accounts can be used to make a QHFD. In addition, a QHFD counts toward any RMD for the year. That means a beneficiary can fund an HSA from an inherited IRA and also satisfy all or part of the RMD for the year with a QHFD.
You receive no tax deduction for the QHFD.
You must remain eligible for an HSA for 12 months after making a QHFD. If you lose HSA eligibility, then the QHFD becomes taxable.
When you’re looking for cash to maximize an HSA contribution for the year, consider an IRA. Despite the limitations, it might let you maximize the value of this powerful retirement planning tool.