IRS details procedures for IRA to HSA transfers (with examples)

The IRS issued guidance on the transfer of funds from an IRA to HSA. This notice provides guidance on a qualified HSA funding distribution from an individual’s Individual Retirement Account (IRA) or Roth IRA to a Health Savings Account (HSA). The qualified HSA funding distribution is a one-time transfer from an individual’s IRA to his or her HSA and generally excluded from gross income.

A qualified HSA funding distribution (I.e. a distribution from the IRA to fund the HSA) may be made from a traditional IRA or a Roth IRA, but not from an ongoing SIMPLE IRA. The qualified HSA funding distribution from the IRA or Roth IRA of an eligible individual to that individual’s HSA must be less than or equal to the IRA or Roth IRA account owner’s maximum annual HSA contribution. Generally, only one qualified HSA funding distribution is allowed during the lifetime of an individual. If, however, the distribution occurs when the individual has self-only HDHP coverage, and later in the same taxable year the individual has family HDHP coverage, the individual is allowed a second qualified HSA funding distribution in that taxable year. Both distributions count against the individual’s maximum HSA contribution for that taxable year. Note, the distribution cannot be made to an HSA owned by any other person, including the individual’s spouse.

An individual must be an eligible individual (eligible to contribute to an HSA) at the time of the qualified HSA funding distribution. The distribution must be a direct transfer from an IRA or Roth IRA to an HSA.

If a qualified HSA funding distribution is made from the individual’s IRA or Roth IRA to the individual’s HSA and the individual remains an eligible individual during the entire testing period, the amount of the qualified HSA funding distribution is excluded from the individual’s gross income and the 10 percent additional tax does not apply. The testing period begins with the month in which the qualified HSA funding distribution is contributed to the HSA and ends on the last day of the 12th month following that month.

The following examples illustrate these rules. It is assumed in the examples that no previous qualified HSA funding distributions have been made by the individual, and that all distributions are from IRAs and are otherwise included in the IRA owner’s gross income. None of the IRAs are ongoing SEP IRAs or ongoing SIMPLE IRAs. None of the IRA owners or HSA account beneficiaries are disabled. None of the exceptions to the 10 percent tax under § 72(t) apply.

Example 1. Individual A, age 45, enrolls in family HDHP coverage on January 1, 2008, is otherwise an eligible individual (as defined in § 223(c)(1)) as of that date and through December 31, 2009. A’s maximum annual HSA contribution for 2008 is $5,800. A owns an IRA with a balance of $2,000. A direct trustee-to-trustee transfer of $2,000 is made from A’s IRA trustee to A’s HSA trustee on April 2, 2008.

The $2,000 distribution is a qualified HSA funding distribution, and accordingly is not included in A’s gross income and is not subject to the additional tax under § 72(t). A’s testing period with respect to the qualified HSA funding distribution begins in April 2008 and ends on April 30, 2009. After the qualified HSA funding distribution of $2,000, $3,800 of A’s 2008 HSA maximum annual contribution remains.

Example 2. Same facts as Example 1, except that A ceases to be an eligible individual on January 1, 2009.

In 2009 A must include $2,000 in gross income, the amount of the qualified HSA funding distribution, plus an additional tax of $200 (10 percent of the amount included in income).

Example 3. Individual B, age 57, enrolls in self-only HDHP coverage effective January 1, 2008, is otherwise an eligible individual as of that date and through December 31, 2009. B’s maximum annual HSA contribution for 2008 is $3,800 ($2,900 plus the $900 catch-up contribution). B owns an IRA with a balance of 13,550. A direct trustee-to-trustee transfer of $3,800 is made from B’s IRA trustee to B’s HSA trustee on June 4, 2008.

The $3,800 distribution is a qualified HSA funding distribution. The distribution from B’s IRA is not included in B’s gross income and is not subject to the additional tax under § 72(t). The qualified HSA funding distribution of $3,800 equals B’s 2008 maximum annual HSA contribution. B’s testing period with respect to the qualified HSA funding distribution begins in June 2008 and ends on June 30, 2009.

Example 4. Individual C, age 38, enrolls in self-only HDHP coverage on January 1, 2008, is otherwise an eligible individual on January 1, and remains an eligible individual through December 31, 2009. C owns an IRA with a balance of $12,550. A qualified HSA funding distribution of $2,800 is made from C’s IRA trustee directly to C’s HSA trustee on June 4, 2008. On August 1, C enrolls in family HDHP coverage. A transfer of $3,000 is made from C’s IRA trustee directly to C’s HSA trustee on August 15, 2008. The $2,800 and $3,000 distributions are qualified HSA funding distributions.

The distributions from the IRA are not included in C’s gross income and are not subject to the additional tax under § 72(t). The qualified HSA funding distributions of $5,800 ($2,800 + $3,000) equal C’s 2008 maximum annual HSA contribution. C’s testing period for the first qualified HSA funding distribution begins in June 2008 and ends on June 30, 2009 and the testing period for the second qualified HSA funding distribution begins in August 2008 and ends on August 31, 2009.

Example 5. Individual D, age 43, enrolls in family HDHP coverage on January 1, 2008, is otherwise an eligible individual on January 1, and remains an eligible individual through December 31, 2009. D owns an IRA with a balance of $17,500. A qualified HSA funding distribution of $5,800 is made from D’s IRA trustee directly to D’s HSA trustee on March 18, 2008. On June 1, D changes from family HDHP coverage to self-only HDHP coverage.

The $5,800 distribution from the IRA is not included in D’s gross income and is not subject to the additional tax under § 72(t). The qualified HSA funding distribution of $5,800 equals D’s maximum annual HSA contribution at the time the transfer occurred. D’s testing period begins in March 2008 and ends on March 31, 2009.

Example 6. Individual E, age 50, begins family HDHP coverage and is first an eligible individual on June 1, 2008. E owns an IRA with a balance of $20,000. A direct trustee-to-trustee transfer of $3,500 is made from E’s IRA trustee to E’s HSA trustee on June 4, 2008. On June 4, 2008 E also contributes $2,300 in cash to his HSA for a total contribution of $5,800.

On July 1, 2009, E ceases to be an eligible individual. The $3,500 distribution is a qualified HSA funding distribution, is not included in E’s gross income, and is not subject to the additional tax under § 72(t). E’s testing period with respect to the qualified HSA funding distribution begins in June 2008 and ends on June 30, 2009. E remains an eligible individual during the qualified HSA funding distribution testing period. No amount of the $3,500 distribution is included in E’s gross income. The testing period for the $2,300 contribution begins in December 2008 and ends on December 31, 2009. E’s full contribution limit under § 223(b)(8) for 2008 is $5,800. E’s sum of the monthly contribution limits is $3,383 (7/12 x $5,800). E’s maximum annual contribution for 2008 is $5,800, the greater of $5,800 or $3,383. The amount included in E’s gross income and subject to the 10 percent additional tax under § 223(b)(8)(B) in 2009 is $2,417 ($5,800 – $3, 383). The cash contribution to E’s HSA is $2,300. The amount included in E’s gross income and subject to additional tax is $2,300, the lesser of $2,417 or $2,300.

Example 7. Same facts as Example 6, except that the distribution from E’s IRA to E’s HSA is $1,000 and E contributes $4,800 in cash for a total HSA contribution of $5,800 in 2008.

E remains an eligible individual during the qualified HSA funding distribution testing period. No amount of the $1,000 distribution is included in E’s gross income. E’s full contribution limit under § 223(b)(8) for 2008 is $5,800. E’s sum of the monthly contribution limits is $3,383 (7/12 x $5,800). E’s maximum annual contribution limit for 2008 is $5,800, the greater of $5,800 or $3,383. The amount included in E’s gross income and subject to the 10 percent additional tax under § 223(b)(8)(B) is $2,417 ($5,800 – $3,383). The cash contribution to E’s HSA is $4,800. The amount included in E’s gross income and subject to the additional tax in 2009 is $2,417, the lesser of $2,417 or $4,800.

Example 8. Same facts as Example 6, except that E ceases to be an eligible individual on May 1, 2009.

The $3,500 distribution is a qualified HSA funding distribution, is not included in E’s gross income in the year of the distribution, and is not subject to the additional tax under § 72(t). E’s testing period with respect to the qualified HSA funding distribution begins in June 2008 and ends on June 30, 2009. E ceases to be an eligible individual during the qualified HSA funding distribution testing period.

The $3,500 distribution is included in E’s gross income. In addition, the 10 percent additional tax ($350) under §408(d)(9)(D)(II) applies to the amount. The testing period for the $2,300 contribution begins in December 2008 and ends on December 31, 2009. E’s full contribution limit under § 223(b)(8) for 2008 is $5,800. E’s sum of the monthly contribution limits is $3,383 (7/12 x $5,800). E’s maximum annual contribution limit for 2008 is $5,800, the greater of $5,800 or $3,383. The amount included in E’s gross income and subject to the 10 percent additional tax in 2009 under § 223(b)(8) is $2,417 ($5,800 – $3,383). The cash contribution to E’s HSA is $2,300. The amount included in E’s gross income and subject to additional tax is $2,300, the lesser of $2,417 or $2,300.

Example 9. Individual F, age 47, has family HDHP coverage and is first an eligible individual on January 1, 2008. F’s maximum annual HSA contribution for 2008 is $5,800. F owns an IRA with a balance of $10,000. A direct trustee-to-trustee transfer of $10,000 is made from F’s IRA trustee to F’s HSA trustee on September 26, 2008.

The $10,000 contribution exceeds F’s $5,800 contribution limit. In 2008, $4,200 ($10,000 – $5,800) is included in F’s gross income under § 408 as a taxable IRA distribution. The $4,200 is also subject to additional tax under § 72(t), as well as an excise tax on excess HSA contributions under § 4973.

Example 10. Individual G, age 32, has self-only HDHP coverage and is first an eligible individual on January 1, 2007. G remains an eligible individual through December 31, 2009. G’s maximum annual HSA contribution for 2007 is $2,850 and $2,900 for 2008. G owns an IRA with a balance of $4,500. A direct trustee-to-trustee transfer of $1,000 from G’s IRA trustee to G’s HSA trustee is made on September 6, 2007. Another direct trustee-to-trustee transfer of $1,500 from G’s IRA trustee to G’s HSA trustee is made on April 28, 2008. G makes no other contributions to his HSA for 2008. The $1,000 contribution to G’s HSA in September 2007 is a qualified HSA funding distribution, is not included in G’s gross income, and is not subject to the additional tax under § 72(t). G’s testing period with respect to this contribution begins in September 2007 and ends on September 30, 2008.

The $1,500 contribution to G’s HSA in April 2008 is not a qualified HSA funding distribution, is included in G’s gross income for 2008 under § 408 as a taxable IRA distribution, and is subject to the additional tax under § 72(t). However, the $1,500 contribution to G’s HSA is allowed as a deduction under § 223(a) in 2008, because G remains an eligible individual in 2008 and has not otherwise made contributions to the HSA or had contributions on G’s behalf made to an HSA in excess of $1,400 for 2008. No testing period under § 408 applies to the $1,500 contribution.