Health Savings Accounts (HSAs) are a great tool for covering medical expenses in a tax-efficient way. To contribute to an HSA, you must be enrolled in a high-deductible health plan (HDHP), and the money can be used for various qualified medical costs. However, one of the main appeals of an HSA is that unused funds roll over year after year, allowing you to save for future medical needs. But what happens when you’re transitioning from a traditional health plan to a high-deductible one and need to quickly build up your HSA balance? One option to consider is rolling over money from an Individual Retirement Account (IRA) to an HSA. Let’s dive into this option and whether it might work for you.

Benefits and Limitations of an HSA

An HSA offers the benefit of growing funds tax-free, and unused funds roll over into the next year. However, as people move from traditional low-deductible health plans to high-deductible plans with an HSA, it can take time to accumulate enough funds in the account. This could leave individuals without the financial resources to cover medical costs immediately. A potential solution is a rollover from an IRA to an HSA, a process that could jump-start your HSA savings.

HSA Rollover: The Basics

You may be eligible for a one-time, tax-free rollover from an IRA to your HSA if you have a high-deductible health plan. However, the rollover amount is capped. It can’t exceed the maximum annual HSA contribution limit for the year, minus any contributions you’ve already made.

How the IRA-to-HSA Rollover Works

The process for rolling over IRA funds to an HSA must be handled as a direct transfer. This means that the funds must go directly from your IRA custodian to your HSA custodian without passing through your hands. It’s best to coordinate this transfer with both custodians to ensure a smooth process.

Eligible IRA Accounts

Not all IRAs are eligible for this rollover. Traditional IRAs, Roth IRAs, and some SEP and SIMPLE IRAs can be used for the transfer. However, SEP and SIMPLE IRAs that received employer contributions during the tax year may not be eligible. Additionally, while you can’t fund an HSA directly from a 401(k), you can first roll over your 401(k) into an IRA and then transfer those funds to your HSA.

Keep in mind that while regular contributions to an HSA can be made up until the tax-filing deadline, the IRA-to-HSA rollover counts within the year it is completed.

Eligibility Requirements for the Rollover

The IRS requires that once you complete the IRA-to-HSA rollover, you must remain eligible for the HSA for a minimum of 12 months. This means you must stay enrolled in your HDHP. If you switch to a non-HDHP plan within that 12-month period, the rollover amount will be added to your taxable income, and you could incur a 10% penalty.

Medicare and the Rollover Rule

It’s also important to consider Medicare. You cannot contribute to an HSA if you are enrolled in Medicare. If you plan to sign up for Medicare within 12 months after rolling over your IRA funds to your HSA, you’ll need to wait until after you’ve completed the rollover. Enrolling in Medicare will disqualify your HSA contributions, and it could result in the testing period failure for the rollover.

Should You Roll Over an IRA to Your HSA?

Deciding whether an IRA-to-HSA rollover is a good move depends on your individual financial situation. If you’re struggling to build up your HSA quickly and anticipate needing the funds for medical expenses, a rollover could make sense. This option might be especially appealing for people approaching retirement, as it provides a way to set aside more money for future healthcare costs. Additionally, if you’re 65 or older, or if you have a disability, you can use the funds in your HSA for non-medical expenses—but note that you will be taxed on those withdrawals.

However, if you have enough savings to contribute directly to your HSA without doing a rollover, it might be more beneficial to keep your IRA intact. Financial advisors typically recommend taking full advantage of tax-advantaged accounts like IRAs. For most people, using other funds to build up the HSA and leaving the IRA untouched is the preferred option.

Which Type of IRA is Best for the Rollover?

If you do decide to proceed with the rollover, it’s generally better to roll over funds from a traditional IRA rather than a Roth IRA. Contributions to a Roth IRA are made with after-tax dollars, so you can withdraw the original contributions at any time without penalty or taxes. On the other hand, traditional IRA contributions are made with pre-tax dollars, so any withdrawals will be taxed and possibly penalized.

Ultimately, deciding whether or not to roll over an IRA to an HSA involves balancing your current financial needs with long-term savings goals. If the rollover would provide a crucial boost to your health savings, it could be a smart strategy. But, if you have other resources available, it’s often better to keep your IRA and save for the HSA separately.

Final Thoughts

While rolling over an IRA to an HSA can provide an immediate infusion of funds for medical expenses, it’s essential to weigh the pros and cons based on your situation. Careful consideration of your health plan, retirement goals, and financial flexibility will help you decide if this strategy makes sense for you.