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Retirement Perspectives

In the third part of a three-part series, we explain rollovers, beneficiaries, and other rules for HSAs.

As more workers enroll in Health Savings Accounts (HSAs), it’s important for them to know all of the benefits and how these accounts can be used. In the last article in our HSA trilogy, we will cover HSA portability, funding an HSA with an IRA, beneficiary naming strategies, HSAs at age 65, and tax reporting.

Rollovers
HSAs are owned and controlled by the employee, not the employer; therefore, there is portability between HSA providers. A rollover isn’t included in your income, isn’t deductible, and doesn’t reduce your contribution limit (in the year of the rollover).

Other rules to know about rollovers include:

  • An individual can roll over amounts from Archer Medical Savings Accounts and other HSAs into an HSA.
  • Rollover contributions don’t need to be in cash.
  • Rollovers aren’t subject to the annual contribution limits.
  • An individual must roll over the amount within 60 days after date of receipt. An individual can make only one rollover contribution to an HSA during a one-year period.
  • IRA assets generally can’t be rolled over or transferred to an HSA. However, there is a one-time exception referred to as Qualified HSA Funding Distribution (QHFD).

Funding an HSA with an IRA: Once-in-a-Lifetime Opportunity
HSAs also offer a little known benefit (in coordination with your IRA): An individual once (in his or her lifetime) can transfer the proceeds from an IRA (not 401(k), 403(b) or qualified plans) to his or her HSA—up to the contribution amount allowed for the year. This transfer is known as a qualified HSA distribution (QHFD).

However, it is permissible to roll over a 401(k) or other retirement plan from a former employer to an IRA and, subsequently, transfer the assets to an HSA. The transfer is permitted from an individual’s IRA in which he/she is the account owner or from an inherited IRA in which he/she is the named beneficiary. The rollover amount cannot be more than the annual HSA contribution limit minus any contributions that are made for the year.

Why would someone transfer his/her IRA assets to an HSA? One potential benefit would be to augment his/her HSA savings in the event of an immediate, urgent, and potentially expensive medical procedure. Another strategy involves moving all of an individual’s pretax "taxable dollars" to an HSA, leaving behind only aftertax dollars, which subsequently can be moved/converted to a Roth IRA, reducing or potentially eliminating the tax burden.

Here are other things to know about QHFD:

  • Transfer can only occur once in an individual’s lifetime.
  • Transfer amount is determined by the contribution limit for the individual in the year of the transfer.
  • IRA proceeds must be moved as a direct trustee transfer. A 60-day rollover is not permitted.
  • Eligible IRAs include traditional, Roth, SEP, or SIMPLE. However, SEP or SIMPLE must be inactive.
  • Distributions are not subject to the IRS “pro-rata” rule. In other words, an individual is not permitted to move aftertax dollars; only pretax dollars are allowed to transfer.
  • QHFD also applies to inherited IRAs.
  • An individual must remain HSA eligible for a one-year testing period after a QHFD to avoid taxes and penalties.
  • In states that tax contributions, federal tax-free rollovers to an HSA, such as IRA to HSA rollover, are treated as a non-qualified withdrawal and subject to income taxes and penalties at the state level. We suggest speaking with your tax professional to determine if you’re impacted.
  • Engage a tax professional, as there is no special 1099-R coding to report the transfer as a QHFD.

HSAs at Age 65
When an HSA owner reaches age 65, he/she gains several new benefits, while others are lost.

  • If a distribution is taken from an HSA and the funds are not used for qualified medical expenses, there is a 20% penalty that applies. HSA distributions after age 65 are penalty free, even if the funds are not used for qualified medical expenses
  • Enrollment in any Medicare coverage (Parts A, B, C, D, or Medigap) will end HSA eligibility [because Medicare is not a high deductible health plan (HDHP)]. Specifically, eligibility to make an HSA contribution ends on the first day of the month an individual turns age 65 and enrolls in Medicare. Notably, prorated contributions are permitted for the months prior to enrolling in Medicare.
  • Generally, insurance premiums are not considered qualified medical expenses. All Medicare premiums (except Medigap) are an exception—these premiums can be paid tax-free with HSA distributions.

Beneficiary Planning
An HSA requires an account holder to name a beneficiary, just as you would with an IRA or 401(k). And similar to retirement accounts, the individual you name inherits the HSA after your death. Moreover, as with retirement accounts, you can name anyone as a beneficiary, including spouse, non-spouse, estate, etc. Naming an HSA beneficiary follows a number of guidelines for group retirement plans and IRAs—but that is generally where the parallel ends.

If your beneficiary is your spouse, then your HSA, upon death, becomes your spouse's HSA. The surviving spouse can continue to access HSA funds, and distributions for qualified medical expenses will be tax free, the same way they would be if distributed to the deceased account owner. However, beneficiaries other than a surviving spouse or the estate must include the full value of the HSA as taxable income in the year in which the account owner dies. So, unless you name your spouse as the beneficiary of your HSA, the account loses its tax-advantaged status as an HSA upon death of the account holder. The amount that is required to be included in gross income by any beneficiary (other than the estate) is reduced by the amount of qualified medical expenses that were incurred by the decedent prior to death and paid by the beneficiary within one year of death.

A non-spouse beneficiary does not have the option of establishing an inherited HSA, which means the option to “stretch” payouts is also unavailable. As a result, limited payout options could lead to receiving a sizable amount of income within a short time frame, potentially bumping a non-spouse beneficiary into a higher marginal tax bracket.

Sometimes an estate is named beneficiary of an HSA. Special rules apply here, too—the total distribution is included on the deceased account owner’s final tax return—not estate beneficiaries.

Tax Reporting
Contributions to an HSA can be made by the account owner, their employer or anyone. Withdrawals from an HSA can be done at any time, age, and for any reason. Therefore, all HSA activity must be tracked and reported.

Here’s what you need to know about HSA tax reporting.

  • The HSA account owner is required to file IRS Form 8889 (“Health Savings Accounts”) with their income tax return each year they make a contribution or take a distribution. This includes contributions that are employer made. Therefore, report all contributions to an HSA on the 8889 and file it along with your Form 1040.
  • If an individual uses a distribution from his/her HSA for qualified medical expenses (QMEs), he/she is not subject to taxation; however, the distribution must be reported on Form 8889.
  • Each year that the account holder takes a distribution, he/she receives the IRS Form 1099-SA (savings account) reporting all distributions. Form 1099-SA reports the amount that was distributed in the year whether it was for QMEs or non QMEs.
  • Non-QMEs are subject to a 20% IRS penalty tax in addition to income tax. Therefore, the account must report any non-qualifying distributions.
  • IRS Form 5498-SA tracks contributions. The HSA custodian or trustee will send the account holder by May 31 following each tax year. Notably, this form is an informational form only and doesn’t need to be filed with your income tax return.

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

A Health Savings Account (HSA) is a savings account that lets employees set aside money on a pretax basis to pay for qualified medical expenses.

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