[Please note reading my prior post, the ABC’s of Retirement Investment Accounts, before proceeding onto this article. Additionally, please take the time to read the website disclosure statement if you already haven’t.]
IRA Rollover … To An HSA?
Ever since I was a young child, I have been told that the only two guarantees in life are death and taxes. Until I began working in finance, I believed this myth to be true. Upon further studying of the tax code, however, I found many exceptions to this myth.
Spoiler alert! I have not discovered the secret to immortality! However, I have found the secret to paying fewer taxes. For today’s post, I will focus on the creation of the HSA and how rolling in IRA dollars can save the average Jill and Joe on their taxes. For a repository of my tax-focused posts, check out this page here.
The HSA, known formally as the Health Savings Account, was created by Congress and established the ability for individuals to contribute money before taxes into a savings account. Once there, the funds can be invested, growing your savings through compound interest. When the time for withdrawing them comes, they are tax-free for most medical expenses, both in the present and future!
Known as the triple-tax advantage, this ability to save, grow, and spend tax-free was and still is unprecedented. With the creation of the HSA, the myth of death and taxes was shattered; people could now eliminate taxes and live for longer, just from using this one account!
Now, the focus of today’s post is a little-known exemption in the tax code known as the IRA to HSA rollover. Allowed once-per-lifetime, the IRA to HSA rollover enables you to take dollars that otherwise would have been taxed and unshackles them to pay for your medical expenses. Before we go any further, let’s go straight to the source on all things taxes!
IRS.gov Facts on the IRA to HSA Rollover
Through studying Publication 969 on IRS.gov, I found the following highlights on how the IRA to HSA rollover process works, plus the requirements:
•HSA funding … may be made from your traditional IRA … to your HSA.
•The maximum funding … depends on the HDHP coverage (self-only or family) … and your age.
•You can make only one qualified HSA funding distribution during your lifetime.
•The total … funding … can’t be more than the contribution limit … to which you are entitled [that year].
•You must remain an eligible … during the testing period … [which] begins with the month … [the] funding … is contributed and ends on the last day of the 12th month following that month.
So, let’s break these above facts and rules into plain English, as the tax code is not a cup of tea that most enjoy sipping.
What is an HDHP & HSA?
HDHP stands for High Deductible Health Plan, and it means that an individual has a high deductible to meet before their health insurance starts covering any medical expenses. For example, if you have a health insurance plan that requires you to spend $5,000 out of pocket before your insurance will start splitting the costs, this could be considered a HDHP plan. (Note: If you are unsure if your health insurance plan is regarded as a HDHP, ask your insurance provider!)
Because deductibles have become significant and expected within the world health insurance, the government decided that Americans needed help. Rather than considering a single-payer system or reigning in costs charged to patients, the HSA account was introduced. Now, individuals could pay medical expenses and meet their deductible without the burden of being taxed on those dollars. Thus, by extending a tax break to all, Congress hoped to make rising medical costs (slightly) more palatable.
HSA’s allow yearly contributions before taxes, similar to IRA and 401(k) accounts. While the limit varies each year, currently, it is $3,600 for individuals and $7,200 for families as of 2021. For those 55+, they can contribute an additional $1,000 in 2021.
Now, here is where you must pay close attention: Those interested in funding their HSA using an IRA are allowed so once-per-lifetime up to the eligible contribution amount for that year.
Translation: If you do this rollover, it lowers your contributions allowed for that year, and they must not exceed that year’s annual limit. Additionally, this rollover can only be processed once, so choose when to use it wisely.
Thus, the most that can be rolled over from an IRA to an HSA as of 2021 is $8,200. For this maximum rollover contribution to be allowed, the account holder must be 55+ and use the account to cover their family’s HDHP medical needs.
Terms & Conditions
As with anything in life, there are specific terms and conditions for the IRA to HSA rollover. As just learned, the first is that this rollover is allowed once-per-life-time, and the second is that it cannot exceed your annual contribution limit for that tax year.
The third condition is that you must be eligible to make an HSA contribution at the time of the rollover and remain so for the next twelve consecutive months; this means that you must continue to use a HDHP for twelve months after the rollover over occurs. Otherwise, the rollover is considered taxable income and is assessed an additional 10% tax upon your regular tax rate.
Fourth and finally, you can rollover funds from a Roth IRA, but you lose the tax advantage when doing this, so I view it as pointless; traditional IRA or no way! Why pay taxes on money that is going into a tax-free account? Exactly, you won’t!
Should I do an IRA to HSA Rollover?
The answer is maybe! Suppose you have a considerable medical expense and do not have sufficient funds in your HSA or emergency fund. Using this rollover, you can cover your deductible, avoid taxes, penalties, and credit card debt, which is a huge net gain! Thus, in this scenario, the once-per-lifetime rollover could make all the difference.
On the other hand, if you can contribute to your HSA each year without financial stress, this strategy should likely be avoided. By doing this rollover, you eliminate the ability to contribute to your HSA for that year. In my opinion, it is better to contribute both to an HSA and IRA directly when possible.
Thus, for those with the ability to maximize their savings, this strategy becomes moot. For those just beginning their financial journey, it becomes a lifesaver! But enough with my writing, what do you think? Is this once-per-lifetime strategy something you will try? Or are you unlikely to use it? Please let me know in the comments below and as always, have a great day!
Mile High Finance Guy
finance demystified, one mountain at a time