The Health Opportunity Patient Empowerment Act of 2006 (adding Section 408(d)(9) of the Internal Revenue Code (“the Code”) provides a limited tax benefit to individuals who contribute to a health savings account (“HSA”) from an individual retirement account (“IRA”). The IRS recently issued Notice 2008-51 (the “Notice”) which offers further guidance on the requirements for receiving this tax advantage. Effective for taxable years after December 31, 2006, eligible individuals may make a one-time, tax-free transfer from an IRA to their HSA, giving individuals with an IRA an incentive to contribute to a HSA. Subsequently, when an eligible individual makes a qualified distribution from the HSA, the transferred funds will not be considered gross income for tax purposes, nor will they be subject to the usual ten percent tax on withdrawals from IRAs.
To be eligible, individuals must be enrolled in a high-deductible health plan (“HDHP”). If the individual fails to maintain HDHP coverage during the applicable twelve month period, then the individual will lose the tax benefits—the total amount of contributions to the HSA will be included in his or her gross income and subject to the additional ten percent tax. The applicable twelve month period begins the month the individual makes the transfer and ends on the last day of the twelfth month following the month the transfer occurred (e.g., if the transfer occurred on May 15th, 2008, the testing period would last until May 31st, 2009). A loss of tax benefits will not occur if an individual becomes ineligible due to death or disability.
To qualify for the tax benefits of the transfer, eligible individuals may transfer only from a single traditional IRA or Roth IRA, not from an ongoing SIMPLE IRA or an ongoing SEP IRA, directly to an HSA. The transfer from an IRA may not be greater than the individual’s maximum HSA contribution for the year. The maximum amount an individual may transfer is based on the individual’s age and type of HDHP (self-only or family coverage) at the time of the distribution. Generally, the Code limits individuals to one transfer from an IRA to a HSA during their lifetime. However, if an individual makes a transfer when he or she has self-only HDHP coverage but obtains family HDHP coverage in the same taxable year, the individual may choose to make a second transfer to a HSA for that taxable year. The same eligibility requirements apply to the second transfer, and both transfers count against the maximum HSA contribution for that year. Finally, if an individual owns two or more IRAs and wants to use amounts in these IRAs to make a qualified transfer, the individual must first make an IRA-to-IRA transfer of the amounts to a single IRA, and then make the one-time qualified distribution from the IRA to the HSA.
For illustrations of the rules regarding a transfer from an IRA to a HSA, eligible individuals should review the Notice, which provides ten examples of distributions along with explanations of the contribution limits and testing periods. Eligible individuals should keep track of their eligibility because the Code does not require employers to report whether an employee remains HSA eligible during the applicable twelve month period.