Can a taxpayer roll-over funds from an IRA to an HSA?

Question of the Week 12/09/20: How to make qualified HSA funding distributions

January 22, 2021

Q: Can a taxpayer transfer funds tax-free from her IRA to her HSA?

My client Anika is 64 years old and plans to retire in a year or two (no firm plans yet). About five years ago her company switched the employees to high deductible health plans and offered HSAs. She has contributed the maximum, including the catch-up contribution, every year since then. Anika was told by another employee that she can make a one-time transfer of funds from her IRA to her HSA and she would like more information about it.

Can my client roll over funds from her IRA to her HSA tax-free? If so, how much can she transfer and what are the requirements or restrictions she needs to consider?

A: Yes, the transfer is called a qualified HSA funding distribution. It has certain limitations and requirements which taxpayers should consider before making the transfer.

Anika can make a tax-free trustee-to-trustee transfer of funds from her IRA to her HSA.

The transfer is called a “qualified HSA funding distribution.” It can be made from a traditional or Roth IRA, but not from a SEP or SIMPLE IRA if the account is ongoing, meaning that contributions are still being made to it.

Qualified HSA funding distribution

The maximum qualified HSA funding distribution depends on the type of coverage Anika has on the first day of the month in which the distribution is made and her age at the end of the year. Because Anika is 64 years old (i.e., at least age 55) she can add up to $1,000 to the qualified funding distribution.

The maximums are:

Self-only coverage

2020: $3,550 + $1,000 = $4,550
2021: $3,600 + $1,000 = $4,600

Family coverage

2020: $7,100 + $1,000 = $8,100
2021: $7,200 + $1,000 = $8,200

Rules and reporting

Generally, a qualified HSA funding distribution is a one-per-lifetime transaction.

However, a taxpayer may be eligible to make an additional distribution if HDHP coverage changes from self-only to family coverage during the same year.

For example, suppose Anika has self-only coverage, makes the maximum ($4,600) distribution in February 2021 and switches to family coverage in June 2021. In that case, Anika could make an additional qualified HSA funding distribution of up to $3,600 ($8,200 – $4,600) any time through the end of 2021.

The HSA qualified funding distribution is reported on line 10 of Form 8889, Health Savings Accounts. The distribution is not taxable and not deductible. It reduces the contributions a taxpayer can make during the year, which Anika needs to keep in mind if she normally contributes regularly to her employer-sponsored HSA, such as through a cafeteria plan.

For instance, if she already contributed the maximum amount to her HSA in 2020 through a cafeteria plan, she’ll have to wait until 2021 to make a qualified HSA funding distribution. During the year, she should reduce or stop her pre-tax contributions accordingly.

A testing period applies to qualified HSA funding distributions

A qualified HSA funding distribution is subject to a testing period, during which Anika must remain HSA eligible.

The testing period begins with the month the distribution is made and ends on the last day of the 12th month following that month. Using the example above, if Anika makes a qualified HSA funding distribution on February 12, 2021, her testing period ends February 28, 2022.

A second testing period applies if an additional distribution is made because the taxpayer switches from self-only coverage to family coverage during the year.

If she doesn’t remain HSA eligible for the entire testing period, the qualified HSA funding distribution is included in income in the year her HSA eligibility ends. In addition, the distribution is subject to a 10% additional tax. The additional tax doesn’t apply for reasons of death or disability, but there is no age exception to this penalty.

Further considerations

These are very important considerations for Anika if she is planning to retire in the next few years. Continuing with this example, if Anika retires in January of 2022 (before her testing period ends) and starts Medicare coverage that month, she would no longer be HSA eligible. On her 2022 return she would include the entire distribution and 10% tax in Part III of Form 8889.

A qualified HSA funding distribution can be a good way to quickly fund an HSA through a tax-free transfer, but Anika should think carefully about her future plans before making the distribution.

See IRS Pub. 969, Health Savings Accounts and Other Tax-Favored Health Plans for more details on HSAs and qualified HSA funding distributions.

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