How to Supercharge an HSA With an IRA Rollover
Which Clients Should Consider This HSA Funding Strategy?
HSAs are a type of triple tax-preferred vehicle. The HSA is funded with pretax dollars, the funds grow tax-deferred and distributions are tax-free if used to cover qualified health expenses. So, with proper planning, the tax benefits of HSAs can exceed the benefits of a traditional IRA (where distributions are taxed as ordinary income).
Most of the time, clients might consider the IRA-to-HSA funding strategy if they are eligible for an HSA, but don’t have enough money to fund it without accessing retirement dollars.
In other words, clients who have enough income to fund both the IRA and the HSA should fund both accounts with non-IRA dollars rather than executing the rollover. Funding with “outside” money allows the client to receive the maximum tax deduction for the year. Essentially, HSA account holders are trading one tax-favored account for another when they execute the IRA-to-HSA rollover.
However, a client who incurs large medical expenses before they have time to build up an HSA balance may be interested in funding an HSA with an IRA if the client would otherwise be required to take an IRA distribution to cover those expenses. This rule allows the client to avoid paying taxes and penalties on an IRA distribution necessary to pay medical expenses.
Clients should also remember that if they have both deductible and nondeductible IRA contributions, rolling the deductible contributions into an HSA can allow them to increase the percentage of nontaxable IRA funds.
While the client can fund the HSA with Roth IRA funds, it’s important to remember that earnings on a Roth grow tax-free over the years. And, because the HSA rollover must be accomplished with taxable dollars, those gains would be rolled over into the HSA — so the client would receive very little benefit.
Conclusion
While HSAs are a powerful tax savings tool, the reality is that many clients may not have the money to fund both a retirement account and an HSA. Those clients might consider the IRA-to-HSA rollover strategy, especially if they’re facing large medical expenses and looking for a tax-preferred way to pay those medical bills.
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