By Katelyn E. Murray, CFP
Health savings accounts, called HSAs for short, work differently from most other types of accounts. I call them financial planning “unicorns” because of how they are treated differently from a tax and estate planning perspective. Over the course of your lifetime, an HSA can be a very effective savings tool to fund medical expenses. The IRS allows people with high-deductible health insurance plans who qualify for the HSA to contribute money on a pre-tax basis to an HSA ($ 3,600 per year for individuals and $ 7,200 $ per year for those with a family plan from 2021). You can withdraw this money, both principle and income, tax-free, provided the funds withdrawn are used to cover qualifying medical expenses.
It would seem that funding an HSA is a no-brainer, and I recommend many of my clients to take advantage of this single account which can provide triple tax savings. However, large HSAs can often become liabilities in the context of estate planning when proper forethought and care is not given to understanding how an HSA inheritance is structured from a tax perspective.
There are three common outcomes for an HSA when the account owner dies:
- If the HSA holder designates their spouse as the HSA beneficiary, the inherited HSA becomes the spouse’s own HSA from the date of death of the account holder. The money remains invested in the HSA and the name of the surviving spouse is simply added to the account. He or she can then make tax-free distributions from the HSA to pay for his or her own eligible medical expenses, just as the original account owner would have. In this case, the HSA is not included in the estate, since it becomes the property of the spouse on the date of the death of the account holder.
- If the HSA holder designates a beneficiary other than the spouse, such as a child, on the HSA, it’s a whole different story.
From the date of death of the account holder, the HSA is no longer considered an HSA for tax purposes and a immediate, taxable distribution of all the balance of the HSA is paid to the beneficiary other than the spouse. He must include the HSA balance in his taxable income in the year of the death of the account holder.
Since the distribution is due to death, the normal 20% penalty that applies to distributions from an HSA that are not used for qualifying medical expenses, does not apply and the beneficiary will pay income taxes at their marginal tax rate on the full amount of the HSA balance, but no penalties will apply. Additionally, any portion of an inherited HSA balance used to pay the account holder’s unpaid medical bills within one year of the account holder’s death will not be taxable to the beneficiary other than the spouse.
In this case, the HSA is not included in the estate, since the total HSA balance is taxed as income to the beneficiary other than the spouse on their own individual tax return.
- If the owner of an HSA designates their estate as the beneficiary of an HSA, the account balance in the HSA is simply included in the gross income of the deceased owner for the year of their death. In this case, the HSA is always not included in the gross estate because it is considered income received by the account holder in the year of his death and is to be declared as income in his final tax return.
The main points to remember here are:
- Make sure your living spouse is listed as a beneficiary on your HSA to avoid your death resulting in a taxable distribution from the account.
- If you do not have a living spouse, consider the tax ramifications of registering a beneficiary other than the spouse, such as a child, since 100% of the account balance will be distributed to that child in the year of. your death and will be taxed at the child’s income tax rate at that time.
- If you are charity inclined and plan to bequeath some of your assets to charity, consider listing a charity as a beneficiary on your HSA, as it will receive the full amount of the account balance with no taxes or penalties owed. . You can always leave the rest of your estate – IRAs, Roth IRAs, 401 (k) s, brokerage accounts, etc. – your children, who will benefit from the advantageous tax status of these accounts and the increase in costs. basis at death.
- Prioritize your HSA spending (to the extent of your eligible medical expenses, and potentially beyond that extent once you turn 65 and are no longer subject to the 20% penalty for withdrawals. not spent on medical bills) rather than your retirement accounts, as your children and other unmarried heirs would rather inherit a tax-efficient retirement account rather than an HSA.
If you are interested in learning more about how your HSA will be managed after your death, or if you do not have an HSA and want to learn more about these unique savings vehicles, consider contacting a qualified financial professional for assistance. ugly. .
About the Author: Katelyn E. Murray, CFP®
Katelyn E. Murray, CFP®, is a paid fiduciary financial planner and behavioral coach with nearly a decade of experience helping clients define their own vision for success and establish a reliable path to it. Katelyn uses her background in financial psychology and behavioral finance to cultivate an integrated financial planning approach, in which elements of behavioral coaching are integrated with traditional expertise in planning and wealth management. As a speaker, she has appeared as a guest on The W Pulse podcast and has been invited to speak at several industry conferences nationwide, including Advisor Group’s ConnectED conference. and The W Forum.