Qualified HSA Funding Distribution
Qualified HSA Funding Distribution (QHFD). What a fun term.
If you are less than 59 years old and have an HSA, consider funding it with your IRA. Especially if an inherited IRA or there is basis in the IRA, as will be mentioned below.
Once in your life, the IRS gives you the opportunity to get Income in Respect to the Decedent out of your IRA and into your “stealth” IRA: your HSA. What is a Qualified HSA Funding Distribution?
What is a Qualified HSA Funding Distribution (QHFD)?
A Qualified HSA Funding Distribution is a once in a lifetime opportunity the IRS gives you. On line 10 of form 8889 you will find the instructions from the IRS. This is a direct trustee-to-trustee transfer of your IRA into an HSA. You don’t include this funding in your income, it is not deductible, and it reduces the amount you can contribute to your HSA from other sources (including employer contributions).
The advantages: this will reduce Required Minimum Distributions by about $300 the first year you take RMDs. The largest advantage is the ability to take pre-tax money and turn it into tax-free money.
Of course, this presumes you use the HSA to invest rather than as a slush fund for your qualified healthcare expenses.
Rules for QHFD
There are rules to follow, such as:
- It must be a direct trustee-to-trustee transfer and not a rollover
- You must remain eligible for more than 12 months after the transfer (known as the testing period)
- Usual contribution limits apply (in 2020 are $3,550 for an individual and $7,100 for a family with a $1,000 catch up if older than 55)
Why do a QHFD When Younger than 59?
IRAs have a 10% early withdrawal penalty if you take the money out before 59.5 years of age. You have access to this money without penalty after that age, but, of course, you have to pay taxes on it.
If you are older than 59.5 years, you can withdrawal money from an IRA at the same time you put money into your HSA and deduct it. A wash.
But doing a QHFD when you are younger than 59.5 give you penalty free access to an IRA in order to fund your HSA.
This is a good option, but using an Inherited IRA may be even a better option.
Why Inherited IRAs to fund Qualified HSA Funding Distribution?
Inherited IRAs, of course, have RMDs. You can take part of your RMD out and not pay taxes on it if you use the money to fund a QHFD. If you have a high income year, it may be especially beneficial to use your inherited IRA to fund a qualified HSA funding distribution.
What about Basis?
The cream-in-the-coffee principal discusses why the pro rata rule ruins Roth conversions. One way to get the cream out of the coffee is a QHFD. Since HSAs only accept the taxable portion of your IRA, you can pull this part out of a mixed IRA and leave your basis behind. Basis is not eligible for QHFD so you can do a Roth conversion on the money left behind and not worry about the pro rata calculation if only basis is left.
Are QHFDs useful in California where you can’t deduct the HSA? What about if you are an employer in the plan and cannot deduct a HSA contribution?
Summary- Qualified HSA Funding Distribution
Once in your life, you can reduce RMDs and fund your stealth IRA (HSA) with a touch of your pre-tax money. Take money that you were going to pay taxes on and turn it into tax-free!
Is this like a backdoor Roth? A backdoor HSA? Nope. But it might come in handy for a few people once in a blue moon. Or do a QHFD once in your lifetime.