A health savings account is one of the most powerful tax-advantaged savings tools, but many people overlook its benefits. Your contributions are tax-deductible (or pretax if through your employer), the money grows tax-deferred and it can be withdrawn tax-free for eligible medical expenses at any time. You can use the HSA money to pay your health insurance deductible, copayments and other out-of-pocket medical bills. Or you can keep the money growing in the account for years and even use it to cover health care expenses in retirement.
The tax law lets you make a one-time rollover from an IRA to an HSA, transforming the tax-deferred retirement savings into an account you can tap tax-free. But the law is limited, and you need to follow a specific procedure to avoid an unexpected tax bill. Here’s what you need to know.
[See: What Is a Health Savings Account?]
How to Roll Over Money From an IRA to an HSA
Rolling over money from an IRA can help you supercharge your HSA. It’s a way to take money that would have been taxable when withdrawn from the traditional IRA and let you access it tax-free for eligible medical expenses.
You can only make the rollover if you’re eligible to make new HSA contributions, which means that you must have an HSA-eligible health insurance policy with a deductible of at least $1,400 if you have self-only coverage or $2,800 if you have family coverage in 2020 and 2021. The amount you can roll over from the IRA is limited to your maximum HSA contribution for the year, which is $3,550 if you have self-only coverage or $7,100 for family coverage in 2020 ($3,600 for self-only coverage or $7,200 for family coverage in 2021). If you’re 55 or older, you can contribute an extra $1,000 for the year.
The rollover only makes sense with a traditional IRA, which would otherwise be taxable, not a Roth IRA, which can already be withdrawn tax-free.
Any amount you roll over reduces your maximum HSA contribution limit for the year. For example, if you have self-only health insurance in 2020 and you roll over $3,000 from an IRA, then you can only contribute $550 to the HSA for the year. You can only make an IRA-to-HSA rollover once in your lifetime, so you need to think carefully about the best time to make this move.
Who Can Benefit the Most From an IRA-to-HSA Rollover?
Since the rollover reduces the amount of new contributions you can make for the year, it’s usually better if you can afford to contribute new money to the HSA instead. That way, you’ll get a tax break for your contribution, in addition to building up tax-advantaged savings for future expenses.
“I think it is better to make new contributions so you can take the tax deduction rather than using the IRA to HSA rollover, but if money is tight or you have large expenses, the rollover is a good way to take care of that situation,” says Roy Ramthun, president of HSA Consulting Services.
Here are some situations where the rollover can be particularly helpful:
Building up your HSA balance, especially when you’re getting started. “If you cannot afford to make new HSA contributions and need money for qualified expenses right away, then this funding method could help,” says Rita Assaf, vice president of retail health savings accounts for Fidelity Investments. “This is especially helpful in the first year of owning an HSA and you need to access funds for a qualified medical expense early in the year before you’ve accumulated much in your HSA.”
You’ll get even more tax benefits if you keep the money growing in the account for the future rather than using it for current medical expenses. “Personally my favorite is to do the rollover at a very young age when they may not be able to make the contribution otherwise,” says Steven Hamilton, an enrolled agent who owns Hamilton Tax and Accounting in Grayslake, Illinois. “This allows the funds to grow in the most advantaged way possible.”
[Read: How to Get Help Paying Medical Bills.]
Providing a tax-free emergency fund. People who have lost their jobs and need to access emergency cash can roll money from a traditional IRA to an HSA and access it tax-free for out-of-pocket medical expenses. They can also use the money tax-free to pay their health insurance premiums if they’re receiving unemployment benefits or if they continued their employer’s health insurance on COBRA after losing their job.
“This might be most helpful for someone who recently lost their job and is now on unemployment or facing COBRA premiums or large out-of-pocket expenses,” says Ramthun. “If cash is hard to come by, transferring money from an IRA to an HSA might be just the ticket.”
Building health care savings as you get closer to retirement. HSAs can be even more valuable after age 65, when you can also withdraw money tax-free to pay premiums for Medicare Part B, Part D and Medicare Advantage plans (but not Medigap). Also, HSAs don’t have required minimum distributions, so you don’t have to start withdrawing money from the account at age 72, like you would with a traditional IRA.
You can roll over more money into the HSA if you’re 55 or older — an extra $1,000 in catch-up contributions.
As you get closer to Medicare age, however, you need to be careful with HSA rollovers. You can’t make new contributions to an HSA — or roll over money from an IRA to an HSA — after you enroll in Medicare. If you sign up for Medicare when you turn 65, your HSA contributions usually need to be prorated based on the number of months before you enroll in Medicare.
Some people who are still working for a large employer at 65 delay signing up for Medicare until they’re older, so they can continue to contribute to an HSA. This is usually only an option if you have health insurance from a current employer with 20 or more employees. But you need to be careful when you finally do sign up for Medicare after age 65 because you’ll receive six months of retroactive Medicare coverage at that point — and you can’t make HSA contributions for those months, either.
How to Roll Over Money From an IRA to an HSA
You need to be careful when you roll over the money to avoid an unexpected tax bill. “The key is that the transfer should be made directly through a trustee-to-trustee transfer,” says Assaf. “You shouldn’t withdraw the money from your IRA first as that could lead to a taxable event and penalties.” Ask your HSA and IRA administrators for their procedure.
Since it’s a once-in-a-lifetime rollover, you may not be able to do the transaction online, even if you have the HSA and the IRA with the same administrator. This is the case with Fidelity, for example. “You should call our HSA specialists to handle the transaction to ensure the IRA withdrawal isn’t treated as a taxable event and that the money rolled over into the HSA is treated as an HSA contribution,” says Assaf.
She says that some administrators may require a paper form and others may not. “The key is to ensure the money rolled from the IRA is treated as an HSA contribution,” she says. “Some HSA administrators may send the trustee-to-trustee check to you, and in this instance you will want to make sure that when you send the check to your HSA administrator to include either a letter of instruction or deposit slip indicating that the check should be treated as an HSA contribution.”
Keep in mind that both IRAs and HSAs are individually owned, even if you are married. The IRA and the HSA must have the same account owner in order to do the rollover, says Ramthun. “Unfortunately, you can’t take from the IRA of one spouse and put it in the HSA of another spouse,” he says.
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Should You Roll Over an IRA to an HSA? originally appeared on usnews.com
