It can depend upon whom that you have named as your beneficiary!
Naming a beneficiary for your retirement account is one of the most important administrative tasks that must be in good order to avoid unexpected or adverse tax consequences. This routine also applies to tax-advantaged Health Saving Accounts (HSAs).
Dealing with death and handling the affairs for a recently passed loved one is emotionally taxing and complicated. The situation can even be more of a problem if the deceased hadn’t satisfied proper legal requirements for his or her accounts. After all, not all financial accounts are passed to heirs in the same manner, especially when it comes to HSAs.
An HSA requires an account holder to name a beneficiary, just as you would with an IRA or 401(k). And similar to retirement accounts, the individual you name inherits the HAS after your death. As with retirement accounts, you can name anyone as beneficiary, including spouse, non-spouse, estate, etc. Naming an HSA beneficiary follows a number of guidelines for group retirement plans and IRAs. But that is generally where the parallel ends.
The treatment of an HSA upon the death of an account holder depends on who is the beneficiary. If your beneficiary is your spouse, then your HSA, upon death, becomes your spouse’s HSA. The spouse beneficiary can continue to access HSA funds, and distributions for qualified medical expenses will be tax-free, the same way they would be if distributed to the now deceased account owner.
However, beneficiaries other than a surviving spouse or the estate must include the full value of the HSA as taxable income in the year the account owner dies. So, unless you name your spouse as the beneficiary of your HSA, the account loses its tax-advantaged status as an HSAupon the death of the account holder. The amount that is required to be included in gross income by any beneficiary (other than the estate) is reduced by
A non-spouse beneficiary does not have the option of establishing an inherited HSA, which means the option to stretch payouts is also unavailable. AS a result, limited payout options could lead to receiving a sizable amount of income within a short time frame, potentially bumping a non-spouse beneficiary into a higher tax bracket.
Sometimes an estate is named the beneficiary of an HSA. Special rules apply here too---the total distribution is included on the deceased account owner’s final tax return---not estate beneficiaries.
We are writing this blog because today more and more people are choosing to set up Health Savings Accounts. Why, because, they are tax-advantaged and because of rising health care costs. Used correctly and with the right beneficiary, these tax savings can continue after the account owner dies.
We thank you for your trust and loyalty. We provide this blog to help educate clients to administer their affairs soundly with continual long-term financial planning.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk, including the risk of loss.
Sources: Internal Revenue Code, Lord Abbett and Putney Klein Associates, Inc.