Key Points
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When your goal is to minimize taxes, leaving your HSA to a spouse is the best bet.
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Non-spouse beneficiaries lose many of the benefits associated with an HSA.
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If your HSA becomes part of your estate, it must go through the probate process.
Given the benefits associated with health savings accounts (HSAs), it’s easy to see why they’re so popular. In addition to HSAs being tax-deductible, the funds are yours to keep permanently. They can even be carried into retirement and used as needed.
If you’re fortunate enough to have access to an HSA, it’s important to know that, once you die, the account isn’t treated like other assets. Here’s what to plan for, depending on who you’ve named as beneficiary.
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When your spouse is the beneficiary
Spouses receive the most favorable treatment when inheriting an HSA. A spouse can treat the HSA as their own, effectively becoming the owner.
Here are three clear benefits:
- Continued tax benefits: Your spouse can continue to make tax-free withdrawals for qualified medical expenses.
- Ongoing contributions: If they’re eligible, your spouse can continue contributing to the account.
- Distribution requirements: There are no mandatory withdrawals.
The nice thing about a spouse inheriting your HSA is how seamless the transition is. In addition, if part of your estate planning involves minimizing taxes, leaving an HSA to your spouse is definitely the most tax-efficient option.
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When a non-spouse is the beneficiary
If you name anyone other than your spouse as beneficiary — including children, relatives, or friends — the account loses its HSA status immediately upon your death, and the tax implications can be significant.
Here’s what leaving an HSA to someone other than a spouse looks like:
- No longer treated as an HSA: Rather than receive the special treatment associated with an HSA, the funds are treated like many other assets.
- Becomes taxable: Non-spouse beneficiaries must include the account’s fair market value as of the date you died in their gross income for the year. However, they can reduce the taxable amount by any qualified medical expense you incurred before death.
The downside of leaving an HSA to a non-spouse is the fact that they’ll owe ordinary income tax on the distribution. While this may not be a burden for some, it can represent a substantial issue for others.
When your estate is the beneficiary
In the event you don’t name a beneficiary or you’ve named your estate the beneficiary, the HSA will revert to your estate. Here’s what happens then:
- Taxes: The final distribution is taxed as income on your final Form 1040.
- Probate: Once the money becomes part of your estate, it must go through the probate process. And due to estate settlement procedures, beneficiaries — who may be planning to make the most of the inheritance — can face significant delays in receiving it.
An HSA is a valuable tool. However, it takes a bit of strategic planning to ensure it continues to benefit those you care about after you die.
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