Think Twice Before Moving Money From An IRA To An HSA

Healthcare costs are continuing to rise year over year. Driven by general inflation, prescription drug price increases, and an aging population, healthcare costs, even for individuals with insurance, are expected to increase by over 8%, according to PwC. In turn, many Americans are looking for smarter ways to cover out-of-pocket medical expenses. One popular choice is moving money from a Traditional IRA into a Health Savings Account, or HSA. On the surface, shifting pre-tax retirement funds into a triple-tax-advantaged account appears to be a smart move. But in reality it's more complicated, according to MarketWatch.

While the IRS does allow a one-time rollover from a Traditional IRA to an HSA under specific conditions, it's not always a smart move. There are strict eligibility rules, contribution limits, taxes, and penalties to know about. So before tapping into your IRA to cover healthcare expenses, it's essential to understand how the IRA to HSA rollover works and whether there are better alternatives.

An IRA to HSA rollover, officially known as a qualified HSA funding distribution, enables eligible individuals to move money directly from a traditional IRA into a Health Savings Account. An important distinction is that this is not as simple as a 401k to Roth IRA rollover, and is only possible with a traditional IRA. Moving money from a Roth IRA does not qualify and can trigger income taxes and withdrawal penalties.

Despite its appeal, the rollover is extremely limited. It can only be done once and is limited to the HSA contribution cap, currently $4,300 for individuals and $8,550 for families. There is also a $1,000 catch-up contribution if over the age of 55. Additionally, to be eligible, you must be enrolled in a high-deductible health plan and not covered by Medicare. You must also remain HSA eligible for 12 consecutive months after the rollover or you risk taxes and penalties. This means that if you lose health insurance during that time, you could incur tax penalties and a 10% early IRA distribution fee.

While rolling over money from your traditional IRA into an HSA can sound appealing, there are simpler ways to fund your account. The easiest is to contribute post-tax dollars from a bank account or pre-tax dollars from your paycheck. Some employers even offer matches based on an individual's own contributions, helping them build up their balance. To get full advantage of an HSA's triple tax advantage, you can deduct your contributions while filing your taxes.

Another way to fund your HSA is by allocating part or all of a bonus or tax refund. Unlike the rollover, these methods don't have the same eligibility requirements or penalties if your health coverage changes. Besides taking advantage of the account's tax-deductible benefit, funding an HSA through paycheck contributions, bonus, or tax refunds, also allows your investments to grow tax-free, and withdrawals for qualified medical expenses will not be taxed either. Before moving retirement funds from your traditional IRA, consider the risks and see if an alternative funding option makes more sense.