Any advantage of pulling money from IRA and putting in HSA?

[Openfire]

I have a client that is currently not working-no income- and wants to pull money from her IRA. She would incur a penalty on this. She would like to put the money into an HSA. Can anyone fathom any advantage for doing this?

[Openfire]

Client is not disabled, and is 59 1/2. She is trying to make it to 65 years old before drawing SS, and is hoping to use her savings and IRA to live on until then, with the plan of living on SS only after that time. She is a former preparer, and has the idea that it may be an advantage to draw extra money from the IRA and pay a penalty on it, and put the money into an HSA. I do not see an advantage here, but wondered if anyone else had any insight?

[Burke]

Well, does she currently have any tax liability at all? Or will she have in 2014? Will the amount she pulls out of her IRA incur such a tax liability? She is limited in the amount she can put in an HSA, so is she going to do this in installments over a period of years? She won't incur a penalty, but she may incur income tax depending on the amount she withdraws. If she plans it correctly, she may withdraw the funds and not pay any tax on them. So why put it in an HSA, since if there is no taxable income to report, there won't be any deduction either. I am a little vague on her reasoning, except that it makes sense to withdraw the funds when she has no income and before she starts earning SS. The only disadvantage is that the protection from creditors is lost.

[Openfire]

Good point about the protection from creditors being lost! She is only wanting to pull out about $5K per year from her IRA.

[Burke]

Perhaps it is also protected in the HSA. Not sure about that, but you can check it out.

[jsamans]

Perhaps it is also protected in the HSA. Not sure about that, but you can check it out.

The 8th Circuit Court of Appeals has affirmed a lower-court ruling that HSAs are trust accounts, not insurance plans, and that because they can be drawn upon for any purpose, they enjoy no inherent protection. Bankruptcy law varies by state, so an HSA may be exempted from the bankruptcy estate in some jurisdictions.

Either way, I'm not clear what the purpose is of moving the money: whatever penalties will exist upon taking it from the IRA will exist regardless of when it happens, so why not just leave the money in the IRA and draw on it for any medical costs that do arise?

[Nashville]

More Thoughts

Some things aren't stacking up - I'm either ignernt or there are misconceptions in this plan.

1. She can't deduct but $2500 put into a MSA. Not $5000 - this changed in 2013. I'm not speaking to whether she can actually PUT more in the MSA, but regardless if she does, she can only deduct $2500. Compliments of Obamacare.
2. There was a remark made about paying the penalty if she draws out too much of her IRA. Since she is 59 1/2, she can draw it ALL out if she wants without penalty.
3. Reducing her IRA balance means she will pay LESS taxation ultimately. It is not an "even swap".
4. "Careful planning" was mentioned by one of our astute members. If not drawing SS and not having much income, she may be able to withdraw MUCH more than what she puts in the MSA and if she doesn't meet her statutory filing threshhold, it will be tax free. Receiving a 1099-R could mean that she has to report and file, but doesn't mean she would have to pay.
5. The more she can take out via 4) above also reduces the balance she will someday have taxability on.

[Gary2]

Some things aren't stacking up - I'm either ignernt or there are misconceptions in this plan.

1. She can't deduct but $2500 put into a MSA. Not $5000 - this changed in 2013. I'm not speaking to whether she can actually PUT more in the MSA, but regardless if she does, she can only deduct $2500. Compliments of Obamacare.

I think you're confusing the FSA limits with the HSA and MSA limits. The HSA limits for 2014 are $3300 for self-only coverage, $6550 for family plan. These limits were not reduced at all by the ACA, but do go up with inflation. MSAs are far less common, and I believe have always been limited to earned income, so they wouldn't apply in this case. As far as I know, the MSA limits haven't changed either.

[Gary2]

The underlying concept seems to be this: If the client is planning on taking money out of the IRA in quantities that will trigger taxes, then if she does the once-in-a-lifetime rollover of $3300 (assuming self-only) from the IRA into the HSA, and then uses that to pay medical costs, that's $3300 that has escaped taxation. It's not a huge amount, but every little bit counts. I haven't looked at this closely enough to be sure that it works, and I don't remember ever seeing it in any of the typical "tax savings tricks" that get published every tax season, but it may have potential.

[mactoolsix]

The underlying concept seems to be this: If the client is planning on taking money out of the IRA in quantities that will trigger taxes, then if she does the once-in-a-lifetime rollover of $3300 (assuming self-only) from the IRA into the HSA, and then uses that to pay medical costs, that's $3300 that has escaped taxation. It's not a huge amount, but every little bit counts. I haven't looked at this closely enough to be sure that it works, and I don't remember ever seeing it in any of the typical "tax savings tricks" that get published every tax season, but it may have potential.

AND - she's over 55, so add an additional $1,000 eligible HSA contribution (rollover).
If she leaves it in the HSA until after age 65, she can use the money tax free for medical insurance.