I know that your death is not what you want to think about, but take the time to understand how your assets, like your HSA, will be treated when you die.

As I’ve written about many times throughout the last several years, health savings accounts are simply wonderful vehicles for not only medical expenses – but retirement planning.

When used properly they’re the only triple tax-free investment account on the planet if used for qualified medical expenses. At worst if used wisely they’re similar to a regular IRA for retirement planning and savings.

But what happens to HSA when you die? Let’s look at many possible scenarios so that you can make the best decision when it comes to naming your HSA beneficiary. 

What are the HSA beneficiary options?

Deciding your HSA beneficiary is a pretty important decision, especially because the handling of the HSA when you die will be different depending on the type of beneficiary listed.

The HSA beneficiary options are:

  • Name your spouse as HSA beneficiary
  • Name a non-spouse (like you children) as HSA beneficiaries
  • Name your estate as the HSA beneficiary
  • Don’t list an HSA beneficiary at all

 Keep in mind that HSAs are handled differently compared to when an IRA is inherited.

Your spouse as an HSA beneficiary

This is what will happen to your HSA when you die and your spouse is the beneficiary:

  • Your spouse will inherit the HSA
    • They can maintain the HSA as if it were their own
    • They do NOT have to be enrolled in a high deductible health plan themselves, nor be covered under your insurance, in order to use the HSA
  • Your spouse can use HSA funds tax-free for qualified medical expenses or even retirement funding after age 65 only

What happens if the inheriting spouse uses HSA funds  (prior to age 65) for anything other than qualified medical expenses?

They will be taxed twice! First, the IRS will apply a penalty tax equal to 20% of the amount withdrawn from the HSA. Then your spouse will face income taxes on the withdrawn amount.

Your non-spouse HSA beneficiary

In the event of a non-spouse HSA beneficiary: 

  • The HSA will cease to exist as an HSA as of the date of the owner’s death
  • The HSA’s fair market value as of the owner’s date of death must be distributed to the beneficiary
  • The distribution is fully taxable to the beneficiary (needs to be included in the income tax of the beneficiary) whether it’s a person or the decedent’s estate
    • There is no 20% penalty however

Is there any way the beneficiary can reduce the tax bill?

The taxable amount of the HSA will be reduced by any qualified medical expenses incurred by the decedent prior to their death.

In this case, the non-spouse beneficiary has only 12 months to use the closed HSA’s funds to pay those qualified medical expenses. 

If the health savings account beneficiary is the decedent’s estate, the value of the HSA is included in the owner’s final income tax return. The amount which exceeds the decedent’s qualified medical expenses will be taxable.

What if the value of the HSA account grows?

Presumably, there will be a lag from the time of death to the closing of the HSA account (in the case of a non-spouse beneficiary). If the HSA funds are invested and grow in value from the time of death to the time of notification of death, the growth will be taxable to the non-spouse beneficiary as if it became a taxable investment account.

Your estate as an HSA beneficiary

The HSA will cease to exist as an HSA on the date of your death and the fair market value of the HSA will be included in your year of death income. 

So who or what should be my HSA beneficiary?

First, don’t try to decide alone, involve your financial advisor and an estate planning attorney before making a decision. Like so many things in life, the answer to this question is: it depends. Let’s look at some different scenarios.

If you are married, it might be best to name your spouse depending on the totality of your circumstances and projected income during retirement.

However, you may have noticed one major difference between spousal HSA beneficiaries and non-spousal beneficiaries, and it’s not favorable to the surviving spouse!

A non-spousal HSA beneficiary has the option to distribute the health savings account and AVOIDS the 20% penalty, only paying income tax on the distribution. This is similar to a regular IRA.

The spousal HSA beneficiary doesn’t have the option of closing the decedent’s HSA and treating it as a death distribution. In this regard, the spousal beneficiary is at a disadvantage, because if they withdraw funds for OTHER than qualified medical expenses prior to age 65 they’ll pay a 20% penalty. 

Presumably, the way this rule was written was to strongly encourage surviving spouses to keep the health savings account intact for future retirement and medical expenses.

Married with a taxable estate vs. a non-taxable estate

If you are married and your estate is non-taxable (as most estates are), it is still most tax-smart to list your spouse as the beneficiary. Your spouse can make your HSA their own, and then even pass on the HSA to other beneficiaries in the future.  

If you are married and your estate is taxable, talk to your attorney about using a revocable trust as the HSA beneficiary. The fair market value of the HSA on the date of your death will still be included in your death year income tax but this strategy will allow your estate tax exemption to fund AB trusts – in the benefit of your spouse. 

Again, the taxes can be reduced by using the distribution to pay for any qualified medical expenses incurred in your year of death. 

If you are an unmarried single HSA account holder, you have two options:

  • Your revocable trust (especially if any beneficiaries may still be minors at the time of your death)
  • Other individual beneficiaries (related to you or not)

If an individual(s) is(are) named, they will have to include the death distribution in their taxable income. 

What if you have a same-sex partner, can you name them as a beneficiary?

If you are married (which is federally recognized) you should be able to name your same-sex spouse as your beneficiary, and the spouse rules will apply.

If you are in a domestic partnership or civil union, your partner will be considered a non-spouse beneficiary. This isn’t the case with all domestic partnerships when it comes to benefits.

For example, domestic partners could be considered for health insurance covered by the partner’s employer. For HSAs, to receive spousal treatment of the decedent’s HSA, you must be married.  

HSA FAQs

Who contacts the HSA custodian to notify them of the account owner’s death?

The spouse, adult child, or (more commonly) the executor of the estate can notify the HSA custodian.

If I named a non-spouse HSA beneficiary should I spend down my HSA?

Again, the answer depends. Under current law, the HSA is an incredible savings vehicle. 

It offers a triple tax advantage and, if invested, can grow over time. The HSA can then provide additional retirement income in your later years and help you (after age 65) cover any expense you want.

Currently, a major question plaguing retired people is “How am I going to pay for medical care?” 

Your HSA, after years of growth, could help you pay for future expenses (especially Long Term Care). So spending down the funds just to help a future non-spouse beneficiary pay less in taxes isn’t necessary. If you know you are nearing the end, or need extra income to cover basic expenses, that would be the time to use those HSA funds. 

Over the years, make sure you are watching for and minimizing fees and expense ratios of your invested HSA funds so that you can maximize growth. 

So, have you named your HSA beneficiary yet?

Knowing all of the exact rules and strategies is difficult, that’s why I encourage you to reach out for help. Talk to your estate attorney and financial advisor to get help making a decision.

But, hopefully, after reading this article, you will be able to answer the question of, “What happens to my HSA after I die?”

As always, if I can help you in any way, don’t hesitate to contact me today.