If you have a health savings account (HSA) and a traditional Individual Retirement Account (IRA), you can take advantage of a nifty tax break. You are allowed a one-time opportunity to move money from a traditional IRA —where it will be eventually taxed—into an HSA where you can use the money tax free for qualified medical expenses.

Dodging the traditional retirement tax bill

Any money you have saved in a traditional IRA will be subject to income tax when you withdraw it in retirement. Regardless of whether you need to use the money or not, the Internal Revenue Service insists that you take annual distributions in retirement so it can collect the tax. Beginning in 2020, these required minimum distributions (RMDs) must start when you turn 72.

Money you save in an HSA today with the intention of using in retirement to cover qualified medical expenses will be tax-free.

A tax-smart move to consider is transferring money you currently have in a traditional IRA into an HSA. The IRS allows an individual to make this move once in their lifetime.

IRA to HSA One-Time Transfer Rules

• The amount you can transfer is equal to the annual HSA contribution limit. In 2020 if you have a high deductible health insurance plan (HDHP) that covers just you, your HSA contribution limit is $3,550. If your HDHP is for your family, your contribution limit is $7,100. If you are at least 55 years old –or will turn 55 any time in the calendar you – you can make an additional $1,000 catch-up contribution.
• There is no tax bill, or early withdrawal penalty when you transfer money from your traditional IRA into your HSA account.
• To avoid a tax bill on an IRA-to-HSA transfer, you must continue to be enrolled in an HDHP for 12 months after the transfer.

Once the money is transferred from your traditional IRA to your HSA it can be used at any time to pay for qualified medical expenses. That can be next month’s copay for some tests, or it can be for health care costs decades from now. That’s where the value of this transfer can really shine.

Let’s say you transfer $7,100 this year into an HSA, and it grows for 30 years earning an annualized 5% return. That will give you nearly $31,000 in tax-free dollars to cover health care costs. If you used $31,000 saved in a Traditional IRA to cover those same expenses, you would owe income tax on every dollar you withdraw. Even at today’s low income tax rates, that adds up. For someone in today’s 22% tax bracket that would mean $220 of every $1,000 you withdraw from a traditional IRA would go to the IRS, leaving you less to cover your expenses. Withdraw the same $1,000 from your HSA to cover a qualified medical expense and you will owe no tax.