WealthyNester.com | tax free IRA to HSA rule

Times are CRAZY in the stock market. You need to look for money in all the right places. Now’s the time!

Did you know that you could transfer IRA dollars straight into your tax-free Health Savings Account (HSA)? AND continue the tax-free ride via your Health Savings Account into the future (provided you are using the money properly to pay for eligible health expenses)? Which is to say: if you follow the rules to the letter, you won’t pay penalties or taxes on those hard-earned (well invested) IRA dollars. This little-known federal tax-free IRA withdrawal opportunity is only available ONCE in a lifetime–and it is worth getting in on it.

NOTE: Most states follow the federal HSA tax treatment, but not all. Contributions can be taxed differently at the state level, and it varies from state to state. Be sure to check your state’s HSA contribution tax rules. Please be sure to consult with a tax professional for your particular financial situation.

What is an HSA?

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Health Matters!

A health savings account (HSA) is an account that is used to pay for specific out-of-pocket medical expenses. It can be set up by your company if you are still working, or by you if you are not. To take advantage of the IRA-to-Health Savings Account opportunity, you MUST be enrolled in a high-deductible, HSA-eligible health insurance plan (HDHP). Other rules apply, as covered in this post, but it is always good to double check and verify with IRS publication 969 to see the list of eligible medical expenses, and review the rules apply to your specific situation*.

Health Savings Account Contribution Limits for 2022

Up to age 50Age 50 and Older

For 2022, the annual contribution limit is $3,650 for individuals. Note that you cannot be claimed as a dependent on another person’s tax return. If you are 50 or older, you can add an extra $1,000 catchup, bringing the total annual contribution to $4,650.

Tip: This transfer can only be used ONCE in your lifetime.

If you are approaching 65, you MUST contribute BEFORE you start Medicare and follow the IRS rules exactly in the year before you start Medicare (at the time of this post, the rule is the last contribution must be one year and a month before Medicare.)

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A Financial Move Worth Looking Into…

This financial move is officially called a “qualified HSA funding distribution.” You have to be be enrolled in a high-deductible, eligible health insurance plan (HDHP) to contribute to an HSA. You can transfer funds from a 401(k) or 457 plan to an IRA first and then to the Health Savings Account–it must be ultimately transferred via an IRA as its final stop before transferring to the HSA.

Deductibles, co-payments, and co-insurance are considered out-of-pocket expenses. Insurance premiums are NOT counted as out-of-pocket expenses. 

….and Doing It Right 

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Make the Transfer correctly

Here’s how to make the IRA transfer correctly, in the current view of the IRS:

  1. The maximum amount you can transfer is your annual HSA contribution limit for your age for the tax year.
  2. The transfer must be made from one IRA custodian to another IRA custodian directly. You cannot deposit the IRA funds in your personal accounts before sending on to the institution where your account is being held.

Be sure to check with your bank, institution, or employer for the correct forms to use when transferring.

Tip: You must remain eligible for and stay in an HSA for a year after the IRA-to-HSA transfer. Be sure to follow this eligibility time test.

Stay on Top of those Pesky 5-Year Roth Rules

What Makes the HSA a Mighty Investment?

HSAs have a lot in common with the mighty Roth IRA, another superb retirement investment vehicle, especially for low- through upper-middle income tax brackets. What makes it so Mighty?

HSA contributions:

  • Can reduce your taxable income
  • Set you up for tax-free growth into the future
  • Give you qualified withdrawals, tax-free

This might not sound like a lot when you are only dealing with $3,650. But due to the magic of compounding, $3,650 will almost TRIPLE in 20 years at 5% without any additional deposits (it will grow to $9,684, and you will have earned in $6,034 in interest).

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The HSA Triple Tax Threat

You can usually invest your HSA funds in most investment instruments (mutual funds, stocks, bonds) that are offered at the institution where your account is located. Investing HSA funds is worth thinking through carefully, of course, as you do not want to have to sell funds at an inopportune time to suddenly get the money out for medical expenses. That said, HSAs give investors the potential for a triple-tax threat advantage:

  1. Pre-tax contributions
  2. Tax-free earnings
  3. Tax-free withdrawals for qualified medical expenses

You have until the April tax deadline to contribute to an HSA for credit on a prior year.

How Do I Access My Funds?

Depending on the HSA account, you are often given several options for accessing your money. Most commonly you will be given a debit card that is linked to your account that can be used to pay for medical expenses at the time of service. For example, Fidelity offers a no-fee, no-minimum HSA account with accompanying debit card. You can also use their online tools to transfer your HSA funds to your personal accounts when reimbursing yourself for medical expenses.

Tip: Be sure to keep all receipts and a paper trail in case you need at any point to justify your tax deduction to the IRS. 

With an HSA, you own the money. The money also automatically rolls over from one year to the next. You can spend, invest or transfer the HSA funds at any time or–in the future after you are no longer on a high-deductible health insurance plan–use it for other uses after age 65. At age 65, you can use the funds for non-medical purposes without paying a penalty (you will pay tax on the funds at your current tax rate, if used that way). If you are disabled, the age 65 rule does not apply.

*Be sure to double check IRS publication 969 (Health Savings Accounts and Other Tax-Favored Health Plans) that covers HSAs, for up-to-date information about rules, limits, and also in the year(s) before you turn 65 to make sure you are following their guidelines.


Disclaimer: All the information provided above  and on this site is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.