Funding a Health Savings Account

Thanks to 2006 legislation, it is possible to rollover funds from an IRA to an HSA – Buy Why Would Anyone Want To?

Rolling money over from an Individual Retirement Account (IRA) to a Health Saving Account (HSA) is possible only once in a lifetime, and only for “eligible” people. Eligibility is determined by the type of healthcare insurance plan one owns. If it is a High Deductible Health Plan (HDHP), then the insured person is good to go. What makes a plan a HDHP? For individual plans, the deductible must be $1400 or more annually and the out-of-pocket limit must be less than $7000. For family plans, those amounts are doubled to $2800 and $14,000 respectively. After the rollover is performed, there is a “testing period” where the account owner must hold the eligible HDHP for twelve months. Otherwise, they would be subjected to a 10% penalty from the IRS.

The maximum amount that can be transferred tax-free and penalty-free from the IRA to the HSA is equivalent to the maximum contribution limit of Health Savings Accounts. For 2021, $3600 could be contributed to HSAs where the owner holds an individual insurance policy, and $7200 for those that hold family plans. For people older than 55, there is also a $1000 “Catch-up” amount allowed for policyholders of both individual and family plans. The HSA contribution limits for 2020 are almost identical, except individual policyholders have a maximum of $3,550.

Advantages of an IRA to HSA Rollover

Pre-tax dollars in an IRA can be moved to an HSA without penalty or taxation. Once in the HSA, the funds can be withdrawn tax-free as long as they are used for qualified medical expenses. For people who are under 59½, this can be advantageous if there are medical expenses that need to be paid. If they don’t use the money for a qualified medical expense, however, the withdrawn funds are not only taxed as income, but subject to a 20% penalty. In fact, the 20% penalty can hit anyone who is younger than 65. Individuals over the age 65 take the tax hit when using HSA funds for nonqualified reasons, but don’t have to worry about the extra 20% penalty

The advantages for people over the age of 59½ not only include the immediate use of tax-free IRA money (for medical expenses), but also the long-term benefits. Imagine the following hypothetical situation:

Fred and Frank both have $3550 in their own IRA. Fred rolls his $3,550 over into an HSA while Frank keeps his put. After 10 years, both amounts grow an identical amount, let’s say 10% per year, so both accounts now have a balance over $9,200. When Fred withdraws his money, he gets the full $9,200 so long as it used for qualified expenses. When Frank takes out his money, he has 24% tax withheld as the money is subject to income taxation, so his net amount is approximately $7000. 

Rollovers from Other Accounts

In the above, the IRAs being discussed are Traditional, not Roth IRAs. While it is just as legal to rollover money from a Roth IRA to an HSA, it makes little sense because Roth funds are already tax and penalty-free when withdrawn (assuming the owner is over 59½ and the money was in the Roth for five years or more when withdrawn). It is also technically possible to rollover funds from a 401(k) or TSP account into an IRA and then rollover the money into an HSA, but this strategy should be discussed with your financial advisor before executing.

For the crowd over 59½, it is also possible to withdraw money from an IRA, take the tax hit, and then deposit the cash into an HSA. An available deduction then essentially offsets the taxes, and this move can be made once every year- not just once in a lifetime like the rollover. However, please discuss this with a tax professional before pulling the proverbial trigger.

For More on Health Savings Accounts:

Until Next Time,

Benefits Ben, STWS

**Written by Benjamin Derge, Financial Planner. The information has been obtained from sources considered reliable but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Benjamin Derge and not necessarily those of RJFS or Raymond James. Links are being provided for information purposes only. Expressions of opinion are as of this date and are subject to change without notice. Raymond James is not affiliated with and does not endorse, authorize, or sponsor any of the listed websites or their respective sponsors.

Funding a Health Savings Account

Funding a Health Savings Account