Health savings accounts (HSAs) allow investors with a high-deductible health plan to use pretax dollars to pay for qualified medical expenses. But what if you anticipate a significant medical expense on the horizon that you don’t have enough funds in your HSA to cover?
If you haven’t already done so, you can make a once-per-lifetime tax-free transfer from your individual retirement account (IRA) to your HSA. Technically, this transfer is called a qualified HSA funding distribution (QHSAFD), but it works similarly to a rollover.
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IRA to HSA rollover
A qualified HSA funding distribution can be made from either a traditional or a Roth IRA. Generally, taking the transfer from a traditional IRA is more advantageous because you would typically pay taxes on any withdrawals from this type of IRA. Withdrawals of contributions from a Roth IRA are already tax and penalty-free at any time, and earnings become tax-free after age 59 ½.
A QHSAFD cannot be made from a SEP-IRA or SIMPLE-IRA when the employer contributes to the IRA in the same year as you want to make the QHSAFD.
Following the same rules, a QHSAFD cannot be made from another employer-based retirement account such as a 401(k), 403(b), or 457 account. However, you can transfer funds from an employer-based retirement account to an IRA and then make a QHSAFD from there.
Transfer Limits to an HSA
The maximum you can transfer to an HSA is a contribution equal to the current HSA contribution limit.
For 2024 and 2025, the limits are:
- Individual coverage: $4,150 for 2024 and $4,300 for 2025
- Family coverage: $8,300 for 2024 and $8,550 for 2025
- Additional $1,000 catch-up contribution for those 55 and older
If your employer contributes directly to your HSA, this contribution counts towards your annual limit.
HSA Eligibility Requirements
Health savings accounts (HSAs) are tax-advantaged accounts that people with high-deductible health plans and no other healthcare coverage (with a few exceptions) can use to pay for eligible medical expenses. You cannot contribute to an HSA if you are currently enrolled in Medicare Part A or Part B or are claimed as a dependent by someone else for tax purposes.
HSAs can provide the following tax advantages:
- Contributions can be made pretax or are tax-deductible
- Investment in an HSA grows tax-free
- Distributions from an HSA to pay for qualified healthcare expenses are tax-free
You must remain eligible for an HSA for a 12-month testing period after you make a QHSAFD. If you lose your eligibility for an HSA before 12 months, the transferred amount becomes taxable income and is subject to a 10% penalty.
High-deductible health plans
The definition of a high-deductible health plan changes periodically. For 2024, a high-deductible health plan is defined as:
- An annual deductible of $1,600 or more for individual coverage or $3,200 or more for family coverage.
- An out-of-pocket maximum that doesn’t exceed $8,050 for individual coverage or $16,100 for family coverage. Premiums do not count toward this out-of-pocket maximum, but deductibles, copayments, and coinsurance payments do.
Eligible HSA expenses
The Internal Revenue Service (IRS) defines medical expenses as:
“The costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes.
Medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. They don’t include expenses that are merely beneficial to general health, such as vitamins or a vacation.”
You can take distributions from your HSA to pay for these qualified expenses. If you withdraw money from your HSA account for a non-eligible medical expense before age 65, you’ll have to pay taxes on the withdrawal plus a 20% penalty. Once you reach age 65, you can withdraw money from your HSA for any reason without incurring a penalty. Nonqualified distributions will be taxed at ordinary income tax rates.
Health savings accounts (HSAs) offer tax benefits, and any unused funds can roll over and continue to accumulate tax-free. HSAs can be used to pay for a wide range of medical expenses and reduce your taxable income. However, everyone may not be eligible.
Depending on your age, retirement, goals, and specific financial situation and objectives, a QHSAFD may or may not make sense for you. Talk with a fee-only financial advisor at Frame Wealth Management. Whether you need assistance with retirement planning, investment management, tax strategies, or comprehensive financial planning, I am here to help.
Give us a call today at 866-395-1786 or contact us online to schedule a meeting and discuss your unique financial needs. Let us be your trusted partner on the path to financial success.
