Health Savings Accounts (HSAs) are very popular among people with high deductible health plans (HDHPs). With this tax-advantaged benefit, a person can use their HSA to cover a large variety of out-of-pocket healthcare expenses. In addition, HSA owners can take advantage of triple tax savings: tax-free funding, tax-free interest, and tax-free distributions for qualified expenses.
However, HSA funding may be a concern for some people. One condition with an HSA is that account owners can only spend their accumulated balance (unlike with a Flexible Savings Account). Nevertheless, there is a little known HSA funding “trick” that owners may be able to put to good use.
HSA owners have a couple of contribution options available to them. Most people make a payroll deduction each payday, though you can also use a post-payroll deposit. You can also build up your account through contributions from a family member or your employer. However, if you’re new to an HSA or have a low balance, growing your balance may be challenging.
There is another option allowed by the IRS if you own a traditional IRA or Roth IRA. According to IRS Publication 969, “a qualified HSA funding distribution may be made from your traditional HRA or Roth IRA to your HSA.”
If you decide to use an IRA distribution to seed your HSA, you can only do it once in your lifetime. There is one exception. If you make a distribution during a month in which you have self-only HDHP coverage, you can make another qualified HSA funding distribution in a later month in the same tax year if you change to family HDHP coverage.
In 2021, your maximum annual contribution is $3,600 ($300 per month) if you have single coverage and $7,200 ($600 per month) for those with family coverage.
For those who are age 55 or older, they can use their catch-up contribution amount to add an extra $1,000 to the annual HSA contribution limit. That amounts to $4,600 for self-only coverage; $8,200 for family coverage.
This is the total HSA contribution you can make for the year, no matter how your account is funded.
Since you can only use this strategy one time, and it counts toward your annual contribution limit, it’s important to think about how you can maximize this trick. Here are some practical reasons to use the qualified HSA funding distribution:
The qualified HSA funding distribution is a little known IRS provision, but it can be very useful depending on your financial situation. Contact your tax advisor or benefits administrator for more information.
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