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IRA Rollover to make HSA Contribution

Nov 24, 2019 | Personal Finance, Tax

Health Savings Accounts (HSAs) are one of the best retirement and investment tools for various reasons.  A HSA is a savings account set up for the sole purpose of paying the qualified medical expenses of the account’s beneficiary or the beneficiary’s dependents or spouse. The HSA can be funded with before-tax employer contributions and/or employee contributions.  Employee contributions are tax deductible.  The contributions may be invested and grow-tax free in the account.  Qualified distributions from the HSA to pay medical expenses are not taxable income.

The annual contribution limit for 2019 for an HSA is $3,500 if you are single and $7,000 for a family plan.  There is an additional $1,000 catch-up contribution available for anyone 55 or older.  In order to be eligible to have an HSA, you must have a qualifying high-deductible medical insurance policy.  In 2019, the deductible must be at least $1,350 for an individual and $2,700 for a family plan.

A good way to fund an HSA is through a qualified HSA funding distribution (QHFD) from a Traditional or Roth IRA.  The rollover from the IRA account, including all contribution sources, may only be up to the annual funding limit. The rollover qualifies as a tax-free transfer from an IRA to an HSA.  Only one QHFD may be made in a taxpayer’s lifetime, even if there are multiple IRAs.  The transfer must be a direct trustee-to-trustee rollover.  If you take a distribution from the IRA and then deposit it into an HSA, the IRA distribution will be taxable.

The QHFD can be made from a Traditional or Roth IRA and also from an inactive SEP or Simple IRA.  There is no 10% early distribution penalty if you are under 59 ½ but only pretax contributions may be transferred in a QHFD. Therefore, just the accumulated investment earnings in Roth IRAs qualify because the original contributions were made with after-tax money.  A high deductible medical insurance plan must also be maintained for the next 12 months or the rollover will become taxable.

A taxpayer receives no tax deduction for a QHFD, but it does qualify as a required minimum IRA distribution.  This could be important for taxpayers with inherited IRAs (but not for Medicare participants, who don’t qualify for HSAs).

Although it’s often overlooked, an IRA is a good source of funding for an HSA.  The transfer will be tax-free and the balance may continue to accumulate tax-free earnings. If it is distributed for medical expenses, the distributions will be tax-free.  This is definitely a gift from the IRS.

Article by Stella Papastephanou, CPA

Photo by Nicolas Tissot on Unsplash

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