Author Topic: Really stupid to optimize for the ACA and not worry about RMDs in our situation?  (Read 3843 times)

poker-wont-help-me-fire

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My husband is 46 and I’m 43, and we just hit our FIRE number.  We have one 7-year-old daughter.  We haven’t retired or set a retirement date yet, but let’s say we retire next year.  RMDs won’t start for us until 75 (or maybe later if the ages are changed again at some point).  I’ve been running the numbers, and I just think it’s almost impossible to optimize for both the ACA and RMDs.  I think I’m leaning towards just trying to keep my taxes and ACA payments low now, and if I have to pay a lot of taxes at 75…well whatever.  That will mean I have a huge tax deferred account and I won’t have to worry about running out of money before I die, which is the whole point of all these optimizations in the first place.   Here are our approximate numbers, if it matters. 

$2 million total portfolio (not including home equity)
$80k annual expense
$10k-$15k in estimated annual income from side hustles
$900k in taxable brokerages/cash (enough to live off of without doing a Roth conversion ladder)
$900k in tax deferred
$200k in Roth

We can probably keep income to 200% of FPL by living off dividends, interest income, side hustle income, and selling from the taxable brokerage as needed. If I don’t do any Roth conversions in the next 30 years, and the tax deferred account grows 6% (real), then it will be over $5 million in today’s dollars after 30 years.  And RMDs will be substantial.  But I will have saved a lot in taxes and ACA subsidies during those 30 years. 

Sandi_k

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I would keep the income low enough for the subsidies for now. At some point, life will intervene, and higher premiums won't bug you as much.

Assuming your portfolio returns 7% real for the next 30 years, it will double every 10 years.

So in 2034 it will be $4M;
in 2044 it will be $8M.
In 2054, at age 75, it will be $16M.

In 2044, you'll be Medicare age. So I'd assume at that point you'll be living on 4% of $8M = $320k annually, and you'll be just fine.

Silrossi46

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Invest the difference of what you don’t spend back into the brokerage account once RMD time comes along. Good problem to have.

reeshau

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We can probably keep income to 200% of FPL by living off dividends, interest income, side hustle income, and selling from the taxable brokerage as needed. If I don’t do any Roth conversions in the next 30 years, and the tax deferred account grows 6% (real), then it will be over $5 million in today’s dollars after 30 years.  And RMDs will be substantial.  But I will have saved a lot in taxes and ACA subsidies during those 30 years.

Keep in mind, it's not the withdrawals from your taxable account that are taxed; it's the gains from your withdrawals.  You have appreciation in your investments, and those won't be uniform.  You can choose to sell the lots that have the least gains, and minimize your income while keeping the cash you withdraw constant.

We have about the same expenses as you do, a 9 year old, but no side hustle.  Rather than absolutely minimize ACA, I look to balance ACA and our nonrefundable tax credits.  In order not to let the tax credits expire unclaimed, I do a Roth conversion to balance taxes to zero.  That's my minimum goal.  If you are ahead of a trajectory that would drain your taxable account, you could go further and fill the 12% tax bracket.

I'm in year 5 of this strategy.  Tax season begins in early November, when the software updates come out, to calculate the balance point.

secondcor521

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It's a tradeoff for sure.

I FIREd at 46 with three kids 21, 16, and 15.

There are also a lot of unknowns.  Future tax laws, investment performance, spending, goals all will change.

Personally I consider loss of ACA subsidies as an additional, parallel tax system.  I try to maximize after tax spendable money by minimizing taxes and maximizing subsidies across the remainder of my life.

In my first few years of FIRE, I did pay very low amounts of taxes between AOTC and living off savings.  I now think that wasn't the ideal choice because I probably gave up the opportunity to pay taxes at 10% or 12% federally now instead of 2x% or 3x% in my 70s.

I now voluntarily pay up to 2x% now to avoid 2y% later, where x is a low number and y is a higher number.  Because of asymmetric risk - you point out the positive side of asymmetric risk as not minding paying lots in taxes if you have lots of money - I don't quite convert up to 2y% now even if it's mathematically "correct".

I used to try to optimize it down to the last dollar.  What I realize now is that the predictions about the future are so uncertain that it's impossible to really do that.  But over 20 or 30 or 40 years of Roth conversions, I do think it's worthwhile to try to convert now at a rate that is close to what you'll probably pay later - filling the 10% bracket to avoid 28% later is 18 cents tax savings on the dollar - a $20K conversion could mean $3600 in tax savings each year.  That is worth - to me - putting pencil to paper even if the math isn't perfect.

I use the CSS spreadsheet developed by MMM member @MDM to determine my Roth conversion each December after accounting for dividends, interest, capital gains, and gig income that I've already received.  It can account for both federal income tax and ACA subsidies combined together.  It designed for a single tax year; I have my own homebrew rough estimate multiyear tax planning spreadsheet to figure out what my "age 70s" tax rates will be.

MDM

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...I just think it’s almost impossible to optimize for both the ACA and RMDs.
The ACA and RMDs are just parts of the tax code, and the thing to (try to) optimize is something like your spendable amount after tax over your lifetime.  Often that optimum comes from minimizing your maximum marginal tax rates over that time.  One can get into optimizing for heirs also if desired....

Note that the ACA will stop when you hit age 65, so that's 10 years before RMDs start.  Whether, when, and how much to convert during your ACA years (or any time) depends on the marginal tax rate you'll incur then vs. what you expect in the future.

Modelling Roth Conversions after FIRE shows one example of what ACA does to marginal tax rates, and Roth Conversion and Capital Gains On ACA Health Insurance has a good tutorial for one way to calculate your own.

Knowing what those rates will be for you "now" is half the battle.  The other half is predicting what they will be in the future.  One back-of-the-envelope calculation is described in that post.

If you try to put your own numbers to "now" (say, assuming 2024 tax rates for what you expect in 2025) and "in the future" (say, after taking SS and RMDs), what do you get?

seattlecyclone

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Given how much the ACA subsidy phase-outs can add to your marginal tax rate I think that minimizing income during the ACA phase of your retirement can often be the best plan even if it means larger RMDs later. I mean, "I have so much money just in pre-tax retirement accounts that my 4% RMD was so much more than I planned to spend all year that the taxes on the excess are a meaningful amount" is a pretty nice problem to have.

mistymoney

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Given how much the ACA subsidy phase-outs can add to your marginal tax rate I think that minimizing income during the ACA phase of your retirement can often be the best plan even if it means larger RMDs later. I mean, "I have so much money just in pre-tax retirement accounts that my 4% RMD was so much more than I planned to spend all year that the taxes on the excess are a meaningful amount" is a pretty nice problem to have.

but it doesn't stay 4% for long!

If you exhaust taxable and roth earlier on, and then have only 401k with 10% withdrawal rate, you might end up paying those high tax rates while your fund dwindles. Maybe it all works out if you can put some aside each year in taxable/savings. Really depends I think.

Most cases - i think it works out fine. But is not guaranteed. Like you re forced into higher than 30% taxes for a few years and then a bad economic decade comes your way later in life. Not likely, but isn't that what we worry about? the uncommon nd ways to prevent?

mistymoney

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And I think OPs post is also applicable outside of ACA subsidies.

In just a general keep taxes lower early on when you can manipulate the situaiton and face a huge (potential) tax bill later. or try to even things out across the retirement years to lower lifetime taxes.

If you pay more taxes upfront with larger roth conversions - the market might really dip for a long period of time and you could have done it all much cheaper over time.

Or maybe successfully stay in the 12% tax bracket with careful conversion stratgies, but a generous market pushes you into the 35% tax bracket by your late 70's and you could even hit higer tax brackets later....all could have been avoided if you filled up to the 24% tax bracket to deliberately shift most of the  401k to roth in the first decade or so....

these thoughts keep up at night!

ok - not really! but I do think of them.

seattlecyclone

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Given how much the ACA subsidy phase-outs can add to your marginal tax rate I think that minimizing income during the ACA phase of your retirement can often be the best plan even if it means larger RMDs later. I mean, "I have so much money just in pre-tax retirement accounts that my 4% RMD was so much more than I planned to spend all year that the taxes on the excess are a meaningful amount" is a pretty nice problem to have.

but it doesn't stay 4% for long!

If you exhaust taxable and roth earlier on, and then have only 401k with 10% withdrawal rate, you might end up paying those high tax rates while your fund dwindles. Maybe it all works out if you can put some aside each year in taxable/savings. Really depends I think.

The RMD percentage is 4.07% at 75, 4.95% at 80, 6.25% at 85, 8.20% at 90, and 11.24% at 95. Most of us won't live to see these >10% RMDs, and not for very many years in any case. You will have been drawing down your IRA from your earliest RMD, so the dollar amount withdrawn each year shouldn't actually be increasing much. If it does...again, good problem to have.

Quote
Most cases - i think it works out fine. But is not guaranteed. Like you re forced into higher than 30% taxes for a few years and then a bad economic decade comes your way later in life. Not likely, but isn't that what we worry about? the uncommon nd ways to prevent?

It's already very easy to have a marginal rate around 30% at relatively low incomes when you're on ACA health care with premium tax credits. Income around 3x the poverty level can often do it. Once you age into Medicare and don't worry about the ACA phaseouts anymore, a single senior would need a gross income over $208.5k to be in the 32% bracket, while a married couple would need about twice that amount.

Paying 30% on a conversion now seems like the wrong risk/reward decision when the downside of not doing that is just if your IRA experiences above-average growth you might have to pay 30% on the last bit of your RMD that you didn't need anyway. What should worry us more than this is what if our investments perform below average? In this case we surely would regret paying 30% on early conversions.

With RMDs at 75 now, you'll have a whole decade between ACA and RMDs. During this time you can take a look at your IRA balance and do some preemptive conversions up to the top of some tax bracket in the 15-25% range (depending on your balance at the time) that should let you prevent the runaway RMD problem without also having the ACA phaseout taxes tacked on top like would have happened at a younger age. If you get to 65 and your IRA just got huge by that time and you don't see a way to keep your RMDs below the $200k range, that's a sign you may have much more money than you need. If the taxes on this excess wealth are getting you down, good news! The tax code lets you transfer up to $100k/year from your IRA to a charity tax-free and this amount counts toward your RMD.

reeshau

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It's already very easy to have a marginal rate around 30% at relatively low incomes when you're on ACA health care with premium tax credits. Income around 3x the poverty level can often do it. Once you age into Medicare and don't worry about the ACA phaseouts anymore, a single senior would need a gross income over $208.5k to be in the 32% bracket, while a married couple would need about twice that amount.

If you are living primarily on long-term capital gains (as in OP's case) your Federal taxes are 0% + ACA phase out.  Much less than 30%.

You still need to watch the development, and the cliffs, when and if they come back.  And, make sure you don't run out of taxable account before you intend to.

seattlecyclone

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It's already very easy to have a marginal rate around 30% at relatively low incomes when you're on ACA health care with premium tax credits. Income around 3x the poverty level can often do it. Once you age into Medicare and don't worry about the ACA phaseouts anymore, a single senior would need a gross income over $208.5k to be in the 32% bracket, while a married couple would need about twice that amount.

If you are living primarily on long-term capital gains (as in OP's case) your Federal taxes are 0% + ACA phase out.  Much less than 30%.

You still need to watch the development, and the cliffs, when and if they come back.  And, make sure you don't run out of taxable account before you intend to.

The OP expects their taxable account to be enough that a Roth conversion ladder will not be necessary to pay their bills during retirement. They have a solid plan for how they will pay their bills from side hustle income, taxable brokerage interest and dividends, plus some capital gains as needed. The main thing they're looking at is whether it makes sense to do some Roth conversions anyway, on top of their existing planned income, in order to reduce RMDs later.

Their side hustle income is expected to amount to about half of the married standard deduction. They also mentioned having some of their taxable brokerage allocated to cash (which would yield interest taxed at regular rates). They might have some other investments (REITs, bonds, etc.) that would also generate income not subject to favorable qualified dividend rates. Including the long-term capital gains they would need to realize to pay their bills, they aim to keep their gross a bit below 200% of the FPL—$74,580$49,720 for a family of three. The amount of space they have left for regular income in the 0% standard deduction zone is perhaps $10k. That amount of conversion might be worth looking into. Beyond that...they'd be paying 10-12% of the next $94k of conversion in federal income tax, the premium tax credit phase-out would add 10-18% more, and once the conversions go beyond about $50k$65k they start pushing some of their 0% capital gains/dividend income into the 15% bracket. The cost sharing reduction cliff at 200% of the FPL is worth real money as well. Add it all up and you're locking in a minimum 20% marginal rate on any meaningful amount of Roth conversion, and it could easily meet or exceed 30% overall.

Now, until the end of the year their kid turns 16, they do have a kid who will be eligible for the child tax credit. Part of that is non-refundable, so for the time being they may have a bit more room to do some Roth conversions without adding to their federal income tax. Only the lost CSR and premium tax credits would be a factor in that range. So for the next several years a Roth conversion in the range of perhaps $10-30k might come in at a reasonable rate. They'd have to run the numbers. The year the kid turns 17 the range of 0% marginal federal tax narrows. A few years later when the kid stops being their tax dependent, their family poverty level goes down so that changes the math a bit on the ACA phaseouts.

I still think the window where both members of the couple are in the 65-75 range is likely the optimal time to do some bigger Roth conversions. They might be able to do some smaller ones at reasonable rates while on ACA insurance, but nothing that really moves the needle.

This stuff is complicated!

edit: multiplied wrong on the 200% of FPL.
« Last Edit: September 24, 2024, 10:59:36 AM by seattlecyclone »

reeshau

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On a practical basis, without the side hustle but otherwise in a similar situation with one kid, and living of taxable investments, I roll over $30k-$40k a year, writing no check to Uncle Sam.

As I get more comfortable the fifth time around in this cycle, I will probably be stretching that further.

secondcor521

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I still think the window where both members of the couple are in the 65-75 range is likely the optimal time to do some bigger Roth conversions. They might be able to do some smaller ones at reasonable rates while on ACA insurance, but nothing that really moves the needle.

Doing smaller ones earlier - as long as they're at reasonable marginal tax cost - might move the needle more than in the 65-75 age range.  Compare age 45 to 65; if invested in stocks and using the rule of 72, every dollar they have at 45 becomes $4 at 65 because of two doublings.  A $10K conversion at 45 gets $40K out of their traditional IRA at age 65; getting $40K out of their traditional IRA at 65 would, on the other hand, require a $40K conversion (or withdrawal).  At age 75 that becomes a $10K conversion vs. an $80K conversion.

This stuff is complicated!

Indeed.  Don't forget that FAFSA is yet another parallel tax system if OP decides to send their kid(s) to college.  When I was doing my calculations, it was another 8% or so of "FAFSA SAI loss" in the ranges I was looking at.

seattlecyclone

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Okay, I plugged some numbers into my favorite tax planning spreadsheet.

Baseline income prior to Roth conversions looks like:
$15k Schedule C side hustle income
$5k interest and non-qualified dividends
$15k qualified dividends
$12k long-term capital gains
AGI $45,940 (199% of FPL)

For health care I plugged in the family ages into my local exchange to get a second-cheapest silver plan cost of $13,968. This exact amount will vary from place to place, but that's not super important. The amount of subsidy lost as income increases will be the same regardless of the sticker price of health insurance in their area. The only difference will be the point at which the subsidy finally phases out to zero.

With this baseline income they get the full $1,600 of refundable child tax credit but not the $400 that is only refundable. Their total tax liability before Roth conversions is negative $12,458.

I graphed the marginal rate (in income increments of $1,000). See attached image.

You can see a few distinct segments here:
  • The rate starts out pretty low in the 10-15% range for the first ~$13k of conversions. This is where they're still using up the standard deduction and nonrefundable part of the child tax credit so the marginal rate only represents the ACA phase-out. Pretty reasonable rate overall, except that this range is also where they move from the 150-200% of FPL tier to the 200-250% tier of cost sharing on their silver plan. In my area that means the family deductible would increase from $1,500 to $5,000 and the out-of-pocket maximum would increase from $5,000 to $15,100. Depending on how much health care you are likely to need in a year, that first dollar of income over 200% FPL could represent a pretty big cliff.
  • The next chunk from $14k-$47k of conversions is taxed from 22% up to a bit over 30%. This is a combination of the 10-12% brackets plus ACA phaseout.
  • The next chunk from $48k-$73k of conversions is taxed at a flat 20.5%. This range starts at 400% of the poverty level where the phase-out goes down to a fixed 8.5% (it's higher below this). That plus 12% income tax equals 20.5%.
  • The next chunk from $74k-$100k is taxed at 35.5%. Here we see 12% direct tax on the Roth conversion plus 15% tax on a dollar of capital gains pushed out of the 0% bracket plus the 8.5% ACA phase-out.
  • From here until the premium tax credit goes to zero we see a 30.5% rate (22% bracket + 8.5% ACA phase-out).

So really, you start with a cliff pretty much at the first dollar with the reduced CSR on their silver plan, there's a very small range of low rates after that, then we get into >20% rates as far as the eye can see.

Again, I'm inclined to say that waiting to lock in the tax on the IRA will likely turn out to be the cheaper option. The cases where it isn't are cases where they end up with more money than they need, so paying a bit more tax is no huge loss. I would advise doing a Roth conversion right up to that 200% of FPL line if they still have room under it, but as long as you can stay under that line while still covering the lifestyle you want during retirement, going over that line doesn't look worth it.

tj

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I would keep the income low enough for the subsidies for now. At some point, life will intervene, and higher premiums won't bug you as much.

Assuming your portfolio returns 7% real for the next 30 years, it will double every 10 years.

So in 2034 it will be $4M;
in 2044 it will be $8M.
In 2054, at age 75, it will be $16M.

In 2044, you'll be Medicare age. So I'd assume at that point you'll be living on 4% of $8M = $320k annually, and you'll be just fine.

They said they plan to retire next year, not in 2044, so don't all of these projections go out the window?

MDM

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They said they plan to retire next year, not in 2044, so don't all of these projections go out the window?
OP hasn't responded to anything, so until that happens....

Turtle

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It doesn’t have to be an all or nothing proposition either.  Even small Roth conversions could make a significant difference later on, especially if it’s a small amount done every year for several years. 

Since the OP mentioned a child, it may also be helpful to keep in mind that whatever is leftover in retirement accounts inherited by children needs to be emptied within 10 years.  Roth conversions make this less of a tax bomb for them. 

I’m in a similar situation of deciding between ACA Goldilocks zone versus Roth conversions, but with 5 beneficiaries (assuming they all outlive me) it will spread the tax burden out somewhat.

MrGreen

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I have considered and modeled this challenge fairly extensively for my own sake and here are my two cents.

If you are able to cover your expected expenses while maintaining a low Adjusted Gross Income and you have no desire to maximize the availability of your money prior to age 60, then there's no benefit in raising your income higher than you have to.

Maximizing the availability of your money prior to age 60 may not be a big deal for you since roughly half of your liquid portfolio is already in immediately accessible form (brokerage account), and maybe 10% more depending on the seasoning of your Roth account. How healthy you are can also weight heavily. If your family requires a lot of medical care, ACA Cost Sharing Reductions (CSR) probably save thousands per year.

We're slightly younger (41 and 39) than you and I expect to raise our AGI above ACA CSR level. However, only 30% of our liquid portfolio is in brokerage accounts and I value maximum utility of our money (the most available) while we're young over tax savings. Assuming no significant changes in the tax code (big assumption there), this is likely the most tax efficient option if we intend to leave all of our money to our child(ren). However, if we intend to donate a considerable percentage of our money when we're older then this would be more inefficient since we paid taxes where they wouldn't have been owed.

Turtle

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New to me idea that I heard recently on a podcast - if your ACA account is HSA eligible and you can access traditional retirement accounts with no penalty, you can remove the HSA contribution amount from your Traditional Retirement Account and use it to fund your HSA.  That essentially functions as a tax free rollover of that amount out of the Traditional account.

There’s also a one time direct rollover allowed according to HSA, which could be from either Roth or Trad, but obviously makes better tax sense to do Traditional.

https://hsastore.com/articles/learn-ira-transfer-rules.html

secondcor521

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New to me idea that I heard recently on a podcast - if your ACA account is HSA eligible and you can access traditional retirement accounts with no penalty, you can remove the HSA contribution amount from your Traditional Retirement Account and use it to fund your HSA.  That essentially functions as a tax free rollover of that amount out of the Traditional account.

This idea only works if you're over 59.5.

The distribution from the traditional IRA is taxable, but the HSA contribution is an adjustment to income, so the two offset each other.  It's not magic; it's just two parts of the tax code that happen to offset each other.

But if you're under 59.5, there will be the 10% early withdrawal penalty in addition to the ordinary income tax.  You still may want to do it, but it's no longer tax free - it'll cost you 10% of whatever amount you "roll over".

I actually do something similar, but I avoid the 10% penalty by doing a Roth conversion and contributing to my HSA directly from my taxable accounts.  Roth conversions aren't subject to EWP.

Turtle

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New to me idea that I heard recently on a podcast - if your ACA account is HSA eligible and you can access traditional retirement accounts with no penalty, you can remove the HSA contribution amount from your Traditional Retirement Account and use it to fund your HSA.  That essentially functions as a tax free rollover of that amount out of the Traditional account.

This idea only works if you're over 59.5.

The distribution from the traditional IRA is taxable, but the HSA contribution is an adjustment to income, so the two offset each other.  It's not magic; it's just two parts of the tax code that happen to offset each other.

But if you're under 59.5, there will be the 10% early withdrawal penalty in addition to the ordinary income tax.  You still may want to do it, but it's no longer tax free - it'll cost you 10% of whatever amount you "roll over".

I actually do something similar, but I avoid the 10% penalty by doing a Roth conversion and contributing to my HSA directly from my taxable accounts.  Roth conversions aren't subject to EWP.

Which is why I said “no penalty” - some folks may also have Rule of 55 if their employer allows it and they are between 55-59.5. 

5 years of it isn’t a giant amount of the Traditional, but in my case every little bit will help. 

seattlecyclone

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New to me idea that I heard recently on a podcast - if your ACA account is HSA eligible and you can access traditional retirement accounts with no penalty, you can remove the HSA contribution amount from your Traditional Retirement Account and use it to fund your HSA.  That essentially functions as a tax free rollover of that amount out of the Traditional account.

This idea only works if you're over 59.5.

The distribution from the traditional IRA is taxable, but the HSA contribution is an adjustment to income, so the two offset each other.  It's not magic; it's just two parts of the tax code that happen to offset each other.

But if you're under 59.5, there will be the 10% early withdrawal penalty in addition to the ordinary income tax.  You still may want to do it, but it's no longer tax free - it'll cost you 10% of whatever amount you "roll over".

There's also the Qualified HSA funding distribution provision in the tax code that lets you roll money directly from an IRA to fill your HSA for that year. This can only be done once in your life. It's better than paying a 10% early withdrawal tax to get the money to max out your HSA, but probably worse than any other method of funding it. Again it's only a one-time thing so not going to really move the needle on your long-term plans even if it does look like a fine thing to do one year.