Why You Might Want to Fund an HSA vs. an IRA

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A health savings account (HSA) is a tax-advantaged account that allows you to set money aside to pay for health care expenses during the year. It can be a great addition to an individual retirement account (IRA) or a 401(k) plan and, if funds are limited, it might be better to contribute to an HSA instead of an IRA. Each have similar rules, but the finer points are different.

Basic Rules for IRAs

A taxpayer must have earned income to contribute to an IRA. Rental income, dividend or interest income, or income from a deferred compensation plan doesn't count under IRS rules.

Annual contribution limits are $6,000 per year, or $7,000 if you're age 50 or older, for 2020 and 2021. These limits include contributions made to both Roth and traditional IRAs but not rollover contributions or qualified reservist repayments. You're limited to the amount of your taxable compensation for the year if your earnings are less than these amounts.

As of January 2020, there's no longer an age limit for making contributions to a traditional IRA, although you used to have to stop by age 70½. You can contribute to such a plan indefinitely as long as you're working.

You get a tax deduction for the amount you contribute to a traditional IRA or a 401(k) if you're eligible, up to the annual contribution limits. Income limits apply as well. The money grows tax-deferred, then you pay taxes when you withdraw it in retirement.

You must begin to take required minimum distributions (RMDs) by age 72 as of January 2020 or face an excise tax. This is somewhat more generous than it was in tax years 2019 and earlier, however. The RMD age used to be 70½.

The rule around RMDs apply to traditional IRAs, not to Roth IRAs. Contributions to Roth accounts aren't tax deductible, but the money isn't taxed upon withdrawal, either, as is the case with traditional IRAs.

Basic Rules for HSAs

You get the same tax deduction with an HSA when you contribute money, but it comes back out tax-free—including interest and earnings—as long as you use the money for medical expenses and qualified health insurance premiums. Contributions made by your employer aren't included in your taxable income, and the money grows tax-deferred.

Contribution limits are $3,550 annually for self-only plans or $7,100 for family coverage as of 2020. The limits are $3,600 annually for self-only plans and $7,200 for family plans in 2021.

You must have a high-deductible health insurance plan that meets certain qualifications to qualify for an HSA, or your employer must offer such a plan.

HSA funds can be used to pay for health insurance premiums after age 65, including Medicare Part B premiums and long-term care insurance premiums. They funds can't be used for health insurance premiums by those under age 65, although they pay for qualified medical expenses such as co-pays, deductibles, and dental care.

HSAs vs. IRAs

You can use the HSA money just like funds in your IRA or 401(k) after you reach age 65 if you don’t need the funds to cover medical expenses or insurance premiums. You'll pay taxes on withdrawals that aren’t used for medical reasons, however, just as you would if you withdrew money from an IRA.

Most withdrawals that are made from an IRA before age 59½ will result in a 10% penalty tax, although exceptions apply. These include up to $10,000 withdrawals for first-time homebuyers and medical expenses that exceed 10% of the taxpayer's adjusted gross income (AGI).

Funds are available from an HSA at any time for qualified medical expenses, however, with no AGI percentage threshold. The penalty tax increases to 20%, however, if the money is used for anything other than medical expenses before you reach age 65.

The contribution limits for HSAs based on income are lower than those for IRAs. And HSAs have no required minimum distributions (RMDs), while IRAs do.

Rollovers From an HSA to an IRA

HSA funds can't be rolled over into an IRA account, nor would there be any reason to do so because you preserve your right to use the funds tax-free for medical expenses at any time with an HSA.

Rollovers From an IRA to an HSA

A tax rule allows a one-time tax-free transfer from your IRA to an HSA. This isn't technically a rollover because it counts toward your annual HSA contribution limit. But it does allow you to move a small amount of money needed for medical expenses from an IRA where you would have to pay taxes on it to an HSA where withdrawals for such purposes would be tax-free.