Can You Transfer an HSA to an IRA? Tax Rules and Key Considerations

Health Savings Accounts (HSAs) and Individual Retirement Accounts (IRAs) are valuable tools for managing financial health, but they serve distinct purposes. Understanding the rules around transferring funds between these accounts is crucial for optimizing tax advantages and retirement strategies.

Differences Between HSA Balances and IRA Funds

HSAs and IRAs differ significantly in purpose and structure. HSAs are designed for medical expenses, offering tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. IRAs, on the other hand, focus on retirement savings, providing tax-deferred growth and, in the case of Roth IRAs, tax-free withdrawals under certain conditions.

Contribution limits emphasize their unique roles. In 2024, the maximum annual HSA contribution is $3,850 for individuals and $7,750 for families, with an additional $1,000 catch-up contribution for those aged 55 and older. IRAs have a $6,500 contribution limit, with a $1,000 catch-up contribution for individuals aged 50 and above.

Investment options also set these accounts apart. HSAs typically provide limited investment choices, such as mutual funds offered by the custodian. IRAs, however, offer a broader range of investments, including stocks, bonds, and ETFs, allowing for more diverse portfolios tailored to retirement goals.

IRS Rules for Qualified Transfers

IRS regulations prohibit direct transfers between HSAs and IRAs because of their differing tax treatments and purposes. However, HSA funds can be rolled over to another HSA within 60 days to avoid tax consequences, with rollovers limited to once per 12-month period.

For IRAs, rollovers are allowed between traditional IRAs, Roth IRAs, and other qualified retirement accounts, provided specific conditions are met. For example, converting a traditional IRA to a Roth IRA triggers income tax on the converted amount, a strategy that can benefit long-term tax planning if executed during lower-income years.

Implications for Taxable Income

Withdrawals from HSAs and IRAs affect taxable income differently. HSA withdrawals for qualified medical expenses are tax-free, but non-qualified withdrawals are taxed as income and penalized at 20% if taken before age 65.

For IRAs, taxation depends on the account type. Traditional IRA withdrawals are taxed as ordinary income, and required minimum distributions (RMDs) begin at age 73. Failing to meet RMD requirements results in a 50% excise tax on the amount not withdrawn. Roth IRAs, by contrast, do not require RMDs during the account holder’s lifetime, offering flexibility in managing taxable income. Converting a traditional IRA to a Roth IRA may reduce future taxable income if done strategically.

How Distribution Penalties Apply

Distribution penalties vary between HSAs and IRAs. Non-qualified HSA withdrawals before age 65 incur a 20% penalty plus income tax. After age 65, the penalty is waived, but withdrawn amounts are taxed as ordinary income.

For traditional IRAs, early withdrawals before age 59½ generally incur a 10% penalty, with exceptions for certain expenses like first-time home purchases or education costs. Roth IRAs allow penalty-free access to contributions anytime, but earnings withdrawn early are penalized unless specific criteria, such as the account being at least five years old, are met.

Non-Qualified Withdrawals

Non-qualified withdrawals can erode the value of HSAs and IRAs through taxes and penalties. HSA withdrawals for non-medical expenses are taxed as income and penalized at 20% if taken before age 65. After that, the penalty is waived, but taxes still apply.

For traditional IRAs, non-qualified withdrawals before age 59½ incur a 10% penalty and are taxed as income unless exceptions apply. Roth IRAs offer more flexibility, with contributions accessible anytime without penalties. However, withdrawing earnings early can trigger taxes and penalties unless the funds are used for qualified purposes, such as a first-time home purchase. Proper planning is essential to avoid unnecessary costs.