What to Consider When Transferring Funds from an Individual Retirement Account to a Health Savings Account

Background

The Health Opportunity Patient Empowerment Act, passed in 2006, included a provision which allows the owner of an Individual Retirement Account (IRA) to make a one-time, tax-free transfer into a Health Savings Account (HSA). This type of transfer is officially referred to as a qualified HSA funding distribution (QHFD) and gives HSA owners an additional way to fund their accounts and save on taxes while planning to cover future qualified medical expenses. Through this transfer, IRA assets are moved directly from the IRA trustee to the HSA trustee as a regular contribution. The election to make a qualified HSA funding distribution is irrevocable.

Who is eligible to make an IRA to HSA transfer?

In order to be eligible to make a QHFD, the HSA owner must be currently eligible to contribute to their Health Savings Account. To contribute, they must be covered under a qualified high deductible health plan (HDHP) and cannot be enrolled in Medicare, have other health coverage, or be claimed as a dependent on someone else’s tax return.

The accountholder must also stay eligible to contribute to an HSA for 12 months following the transfer. If funds are transferred, and then the accountholder loses HDHP eligibility before 12 months from the transfer, the QHFD will be taxable and is subject to an additional 10% tax. (Taxes do not apply in cases of death or disability of an HSA-eligible individual.)

How much can be transferred?

This special type of transfer does not change the amount that is allowed to be contributed to an HSA in a tax year. When combined with other HSA contributions, the total is limited to the annual HSA contribution limit. This limit depends on the type of HDHP coverage, individual or family, at the time of the distribution as well as the age of the accountholder.

In 2023, the limits will be as follows:
Individual contribution limit: $3,850
Family contribution limit: $7,750
Catch-up contribution limit for age 55 and up: $1,000

If the HSA owner switches from individual to family HDHP coverage during the year in which a transfer is made, they may make an additional qualified HSA funding distribution in that same year so that the total distribution amount equals the larger regular family contribution limit. This is the only exception to the once-in-a-lifetime rule.

Also, please note that the qualified HSA funding distribution relates to the taxable year in which the IRA transfer is made. Generally, accountholders can contribute to an HSA for a tax year by depositing an HSA contribution no later than the tax filing deadline of the following year, but in this case, the IRA transfer counts toward the contribution limit in the year it is transferred, even if transferred between January 1 and the tax filing deadline.

Which types of IRAs may the transfer come from?

The transfer into the HSA can come from a traditional IRA, Roth IRA, inactive simplified employee pension (SEP) IRA, or inactive SIMPLE IRA. Distributions cannot be made from “ongoing” SEP or SIMPLE IRAs. SEP and SIMPLE IRAs are considered ongoing if the employer is making contributions to them for the plan year ending with or within the IRA owner’s tax year in which the qualified HSA funding distribution is being taken.

If an accountholder has multiple types of IRAs, it is best to consult with a tax advisor to determine which type of IRA to transfer, but here are some things to consider:

• Distributions from traditional IRAs are usually subject to taxation. Accountholders can reduce their tax burden when money is transferred from a traditional IRA to an HSA, since distributions from the HSA are not taxed for eligible HSA expenses. 
• Contributions to a Roth IRA are taxable to the accountholder but can be withdrawn tax-free at any time. HSA-eligible individuals can withdraw contributions from their Roth IRA and contribute them to their HSA rather than making a trustee-to-trustee transfer. However, earnings that accumulate from investments in a Roth IRA have not been taxed and may be subject to tax when withdrawn. When specified requirements are met, earnings are not taxed, either. Generally, to avoid taxation on Roth IRA earnings, the accountholder must be age 59 ½ and the Roth IRA must have existed for at least five years. There may be other applicable exceptions as well. Accountholders may want to keep their funds in a Roth IRA instead of making a transfer to an HSA because Roth IRA distributions may not be taxed in the future and distributions can be made for any reason, not just to pay medical expenses.

Can a qualified HSA funding distribution be used to satisfy a required minimum distribution (RMD)?

Yes, a qualified HSA funding distribution may go toward satisfying RMDs for IRA owners and beneficiaries.

Other Ways to Fund an HSA with retirement funds

If the HSA accountholder is 59½ or older and needs to fund their HSA for medical expenses, they could take a regular withdrawal from their IRA and use it to contribute to their HSA. They would be taxed on the withdrawal from a traditional IRA, but those taxes and the tax deduction from the HSA contribution should practically cancel each other out. And this can be done more than once—in fact, every year if desired.

There are a few other strategies worth mentioning:

• If the HSA accountholder has funds in another type of retirement account, such as a 401(k), or a 457 plan, they may be rolled into an IRA before being transferred to the HSA.
• Because only one tax-free IRA-to-HSA transfer is allowed, an accountholder with multiple small-balance IRAs could transfer money from IRA to IRA (if possible) to combine them first, then make one transfer to the HSA. 

Due to the nature of these more complex situations, it is best to consult with a tax advisor or financial planner before beginning the process.