A reader asked me about the once-in-a-lifetime transfer from an IRA to an HSA, officially known as the qualified HSA funding distribution. It’s one of those things that just because you can doesn’t mean you should. In all likelihood you are better off not knowing this option even exists.
Still Must Qualify For HSA Contribution
In order to do the once-in-a-lifetime transfer from an IRA to an HSA, you still have to qualify for making a contribution to the HSA. That means having an HSA-eligible high deductible health plan with no other coverage.
Eat Into HSA Contribution Limit
The once-in-a-lifetime transfer from an IRA to an HSA does not increase your HSA contribution limit. The maximum you can transfer is your normal HSA contribution limit. It’s not on top of your normal contribution limit. If you do the transfer, it reduces dollar-for-dollar the amount you can contribute in other ways, either directly or through your employer.
No Tax Deduction
The transfer from your IRA to your HSA is not taxable, but you also lose the tax deduction you otherwise would get if you contribute normally. As a result, compared to just contributing normally, doing the transfer raises your AGI in the same way as taking a withdrawal from your traditional IRA except you don’t have to pay a penalty if you are under 59-1/2. Raising your AGI increases your taxes. It can make you lose other tax benefits.
Gotcha Testing Period
If you do the transfer you must also commit to staying with an HSA-eligible high deductible health plan with no other coverage for 12 months. If you fail the commitment, the transfer becomes taxable and you’d have to pay a 10% penalty. There’s no such requirement if you contribute normally unless you invoke the last-month rule in order to contribute more than you are allowed otherwise.
Once In A Lifetime
With so many restrictions the transfer is still limited to just once in a lifetime, of a few thousand dollars.
I really don’t know what the point is in pulling money from one account to another, raising your AGI, paying more taxes and putting yourself into a gotcha trap. The once-in-a-lifetime restriction makes it sound like an opportunity you shouldn’t miss. Actually it’s practically useless.
If you have other money you can use to make a contribution to your HSA, just use your other money. You lower your AGI and you reduce your taxes. Your IRA will continue to grow for your retirement.
If you absolutely have no other money to fund your HSA but you are already 59-1/2, you can just take a regular IRA withdrawal and simultaneously contribute to your HSA. The income on the IRA withdrawal and the tax deduction for the HSA contribution will create a wash. You can do it every year if you want to and there is no 12-month commitment.
If have no other money to fund your HSA and you are not yet 59-1/2, compared to just taking a regular IRA withdrawal to fund the HSA, doing the transfer from your IRA to your HSA amounts to a penalty-free, but not tax-free, withdrawal of a few thousand dollars from your IRA. The penalty relief is limited to just once in your lifetime, and it comes with gotcha strings attached. It’s not that useful. You are better off letting your IRA grow undisturbed.
In summary, doing the once-in-a-lifetime transfer from an IRA to an HSA is:
- better than withdrawing from the IRA but not contributing to the HSA (why would you not contribute?)
- better than paying a penalty to withdraw from the IRA when you are under 59-1/2 to contribute to the HSA (just use other money to contribute and leave your IRA alone)
- worse than doing a regular withdrawal from the IRA to contribute to the HSA (limited to once-in-a-lifetime, have testing period)
- worse than using money outside the IRA to contribute to the HSA (higher taxes; less health insurance subsidy)
Bottom line: forget about the one-time transfer from your IRA to your HSA.