When Should You Make an IRA-to-HSA Transfer?
Did you know that it is possible to make a tax-free transfer from an individual retirement account (IRA) to a health savings account (HSA)? It is such a rarely used and little-known rule that, to be honest, I didn't know about it either until recently when a colleague informed me of it.
Frankly, at first, I had a hard time conceiving of when or why someone might want to do this, especially since all other things being equal, wise financial planning would suggest that you fully fund both types of accounts and take the tax deductions afforded each, if that makes sense for your situation. But upon reflection, there could be situations where someone who has high medical costs but insufficient cash flow to cover them might benefit from this once-in-a-lifetime move, known as a qualified HSA funding distribution.
To qualify, you must be eligible to contribute to an HSA to begin with, meaning you are currently covered by a high-deductible health plan. Further, the amount transferred is limited to the maximum amount that you can contribute directly to the HSA. For 2022, that's $3,650 for those with individual coverage, or $7,300 for family coverage. If you are age 55 and older, you can add an extra catch-up amount up to an extra $1,000 to each of those maximum amounts.
From these amounts, however, you have to subtract the amount of any employer contribution to your HSA, as well as, any contribution you may have already made to the account, in determining the amount you can transfer.
Important to know is that funds transferred this way are NOT tax deductible like a normal HSA contribution would be. However, the transfer out of the IRA is also not taxable, as a typical traditional IRA withdrawal would be. Another rule you should know, it is your HSA provider who must initiate the transfer directly from your IRA account.
So back to my original musings about when making such a transfer would be the thing to do. Here is what I have come up with. As stated earlier, such a transfer from an IRA to an HSA could benefit those who, in a single year, have large medical costs but not enough available cash (or existing HSA funds) to cover them without tapping into tax-qualified retirement funds.
If the needed funds were simply withdrawn from a traditional IRA and then used to pay the medical bills, income tax would be owed on the IRA withdrawal. Additionally, if you are under age 59 1/2, you also could potentially owe a 10% early withdrawal penalty on that money.
However, money withdrawn from an HSA, so long as it is used to pay for qualified medical costs, is both income tax and penalty free. Believe it or not, this transfer rule allows you to take the money tax-free out of the IRA, place it in the HSA, then withdraw from the HSA to pay the medical expenses, thus avoiding all taxation on the IRA monies. There aren't many "gimmes" in tax law, but this seems to be one.
This strategy could also be used to prepare for medical expenses you know are coming in the future for which there will not be enough other available funds to pay.
I suppose, with the ability to invest HSA funds just as you could any other accounts, there is one other possible situation where you might want to make this transfer. This would be to get enough money into the HSA account so that it could be invested and begin to grow, knowing that so long as it was used in the future to pay qualified medical expenses, all the investment income earned would be ultimately tax-free, unlike typical investments or even traditional IRAs. Of course, again, you would only want to fund it this way if you are not able to make a tax-deductible contribution to fund the HSA.
And one other note of worth - even though this is a once-in-a-lifetime transfer, there is an exception to that. If the rule is used when you have individual only health insurance coverage and later you switch to family coverage that same year, you can make another transfer up to the maximum allowed for family coverage discussed earlier.
Lane Keeter, CPA, is Office Managing Partner of the Heber Springs office of EGP, PLLC, CPAs & Consultants (a full-service financial firm with offices in Heber Springs, North Little Rock and Bryant) and past winner of The Sun-Times Reader's Choice Award for Best Accountant
