Special Once-in-a-Lifetime IRA transfer to HSA
IRS Notice 2008-51Once per lifetime an individual may make a tax-free, trustee-to-trustee transfer to their HSA from an IRA or Roth IRA, but not from a SEP-IRA or SIMPLE-IRA unless no current contributions had been made to the SEP or SIMPLE for the same plan year.
The maximum qualified HSA funding distribution depends on the HDHP coverage (self-only or family) you have on the first day of the month in which the contribution is made and your age as of the end of the tax year. The distribution must be made directly by the trustee of the IRA to the trustee of the HSA. The distribution isn’t included in your income, isn’t deductible, and reduces the amount that may be contributed to your HSA. The qualified HSA funding distribution is shown on Form 8889, Line 10 for the year in which the distribution is made.
You can make only one qualified HSA funding distribution during your lifetime. However, if you make a distribution during a month when you have self-only HDHP coverage, you can make another qualified HSA funding distribution in a later month in that tax year if you change to family HDHP coverage. The total qualified HSA funding distribution can’t be more than the contribution limit for family HDHP coverage plus any additional contribution to which you are entitled, and must be reduced by any current year HSA contribution already made.
Practical Tip: Dollar for dollar, an HSA is better than an IRA. There is no RMD requirement from an HSA, plus money withdrawn from an HSA to pay qualified medical expenses is non-taxable.
IRAs have an RMD requirement and money withdrawn from an IRA for medical purposes is always taxable and sometimes penalized.
Example 1 Layne is a 24-year old individual with an IRA ($10,000 value) he has funded with earnings from part-time jobs in prior years. His 23-year old wife Madison also has a $10,000 IRA funded with prior year earnings.
Both start new jobs this year, and they obtain family qualified-HSA coverage for the entire year through Madison’s job. They have enough money to put $5,500 in an IRA or in an HSA, but not both.
Put $5,500 in an IRA and deduct it. Then have one of them do the once-in-a-lifetime transfer to the HSA for this year. That way the money is in the HSA for future medical needs. They get a deduction for the $5,500 IRA deposit and they obtain a tax-free transfer to their HSA from the IRA for the full family deposit limit of $6,900, leaving $8,600 in the IRA ($10,000+5,500-6900) and $6,900 in the Health Savings Account to use without tax or penalty on any medical costs incurred since opening the savings accounts.
If you are really a great planner, have them do the same next year, even if they have enough money to put in both the IRA and the HSA. Fund and deduct 2 IRAs, do the lifetime transfer for the HSA and now there is $13,800, in total, in much more usable and flexible HSA accounts.
Note that they do not get a deduction for the IRA to HSA transfer, but the transfer enabled them to take money out of the IRA tax-free, while still making a current year IRA contribution.
Example 2 Next year Layne & Madison have a baby and they need $5,000 to pay the deductible on the birth of the child. If they took it out of an IRA they would pay tax and possibly a 10% early withdrawal penalty. If they take it out of their new HSA accounts it is not taxable!