Getting money into your IRA is pretty easy. Getting it out without paying a boatload to Uncle Sam? That's the hard part. But there's one way you can take money from your IRA tax-free to help with medical expenses.
The amount of wealth that people have saved in IRAs is larger than Congress could have imagined when it created the accounts in 1974. According to the Employee Benefit Research Institute, IRA accounts held $4.23 trillion in assets at the end of 2006. Having enjoyed tax-deferred growth over the years, accountholders will eventually have to pay taxes on all that money.
But in an effort to promote health savings accounts, which have only been around for a few years, the tax laws now let you transfer some of your IRA money to fund an HSA without having to pay tax.
How to take advantage
To take advantage of this opportunity, you must first find out whether you qualify for a health savings account. To qualify, you need to be covered by a high-deductible health plan -- a health-insurance plan where you're responsible for paying a substantial amount of your own medical costs before the insurance kicks in. In this case, you have to pay at least the first $1,100 of your own expenses for an individual plan, or $2,200 for a family plan. Most health-insurance providers, including Aetna (NYSE: AET ) , Cigna (NYSE: CI ) , and Humana (NYSE: HUM ) , offer at least one HDHP option. To compensate you for having to pay more of your own expenses, HDHP premium costs are often quite a bit lower than traditional health insurance.
Once you're covered, you can open an HSA. Your health insurer may offer an HSA option to go with your health insurance. In addition, banks like Wells Fargo (NYSE: WFC ) and Bank of America (NYSE: BAC ) offer sophisticated HSA plans that give you many different investing options.
After you open the HSA, making a tax-free rollover is relatively simple. You simply need to direct the broker or bank that holds your IRA to transfer money to your HSA provider. You can move up to $2,900 in 2008 if you have single coverage, or $5,800 if you have family coverage.
Using your HSA
The best thing about having a health savings account is that you can use that money to pay your medical expenses without any tax hit. For example, if you simply took money out of your IRA to pay a $3,000 medical bill, you might pay more than $1,000 in taxes, depending on your tax bracket. With an HSA, however, you can pay medical bills without incurring any income tax at all.
In addition, money in your HSA enjoys the same tax-free growth that IRA money does. So as your account assets earn income, you'll have more money available to pay health-related expenses. And unlike the flexible spending accounts that many employers offer, you don't have to forfeit your money if you don't need it that year; you can carry it forward to future years.
Unfortunately, the IRA-to-HSA rollover isn't something you can take advantage of repeatedly. The law specifies that it's a once-in-a-lifetime option. So if you have a bunch of money tied up in your IRAs, you won't be able to drain them completely using this method. But as an incentive to open a health savings account, the rollover technique can be a smart move toward saving on health insurance costs.
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