Financial Planning for December 2013

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Tax Free HSA Transfers Provide for Savings

The Health Savings Account (HSA) was originally created to offer a financial incentive for individuals enrolled in a high deductible health care plan (HDHP) to save and help pay for some of their own health care expenses. However, it also offers a tax advantage for retirees who would like to siphon off some of their saved retirement plan assets into an account designed specifically to pay for medical care.

The HSA allows for a small but interesting tax loophole for people who have built up savings in an IRA and even a 401(k) account. When you withdraw funds from these tax-deferred retirement accounts, those amounts will be taxed at your ordinary income rate in the year withdrawn. However, one way to avoid taxes on those assets – or at least a portion of them – is to conduct a tax-free transfer into an HSA account.

You may make a one-time contribution in the form of a direct transfer to your HSA account from your IRA account, up to your maximum annual HSA contribution limit. Note that this contribution amount may not be deducted from your income on your tax return.

However, you do not have to pay taxes (or penalties) on the IRA distribution, as you would if you paid for medical expenses with funds from your IRA. In fact, as long as you use the money withdrawn from your HSA for qualified medical expenses, you won’t ever have to pay taxes on money transferred from a traditional IRA. The IRA-to-HSA rollover is subject to a 12-month testing period during which time you must remain HSA-eligible. You can also contribute to an HSA from your Roth IRA, but since you’ve already paid taxes on Roth assets you wouldn’t benefit from the tax advantage.

You can also use this tactic with a 401(k) plan, but you would need to roll over the assets to an IRA first, and then conduct the transfer to an HSA, subject to your annual contribution limit.

This strategy can be quite valuable if you’re starting to plan for your retirement income. Not only can it supplement a separate savings account designed for health care expenses, but also it can reduce the tax liability of invested retirement plan assets.

HSA Details

Premium rates for HDHPs are generally lower than that of other health plans, which allows participants to save additional funds to help pay for their health care expenses. Therefore, relatively healthy participants who do not have a lot of medical expenses throughout the year can accumulate significant savings over time in an HSA.

In 2014, the HSA contribution limit is $3,300 for an individual and $6,550 for a family, indexed for inflation each year. For those age 55 or older, there is a catch-up provision that allows you to kick in another $1,000; this limit is not indexed for inflation.

HSA funds may also be used to reimburse the money withheld from Social Security benefits to pay for Medicare Part B, pay Part D or Medicare Advantage premiums, and pay for a portion of long-term care insurance premiums.

HSA accounts offer the following tax breaks:

  • Contributions are not subject to income taxes
  • Assets have the potential to grow tax free
  • Funds used to pay for qualified medical expenses may be withdrawn tax free

Note that any non-qualified withdrawals made before age 65 will be subject to both income tax and a 20 percent penalty on the amount withdrawn. However, once an account owner turns 65, he may use HSA funds for any purpose, not just medical expenses – which is why the HSA can be an excellent tax-free vehicle for retirement savings. Bear in mind though that amounts withdrawn after 65 for non-qualified medical expenses will be subject to income taxes – but no other penalties. 


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