Have a Health Savings Account? Do you know what happens to your HSA when you die?
An HSA account is a tax-exempt, medical savings account that is available to United States taxpayers who are enrolled in a high-deductible health plan. Over the last few years, HSA accounts have become more common. However, many HSA account owners are unaware of the implications of the rules governing HSA accounts in the event of their death.
Death of an HSA Holder
If you die with an HSA account and you have named your spouse as the designated beneficiary of your HSA, then the HSA will continue to be treated as your spouse’s HSA after your death. Your spouse will then be able to use the money tax-free to pay for qualified medical expenses even if your spouse is not enrolled in a high-deductible health plan. Your spouse will also be able to use the account funds to pay for any qualified medical expenses that you incurred prior to your death if your spouse pays those expenses within a year of your date of death. However, if your spouse is younger than 65, takes a distribution of funds, and uses the funds for something other than medical expenses, then your spouse will be required to pay a 20% penalty tax on the amount withdrawn plus income taxes. (This is the same rule that applies to you while you are alive.)
If you named someone other than your spouse as the HSA account beneficiary, then the HSA account stops being an HSA, and the fair market value of the HSA becomes taxable to the beneficiary in the year in which you die. However, the taxable amount can be reduced by any qualified medical expenses that you incurred prior to your death if those expenses are paid by the beneficiary within a year of your date of death.
If no beneficiary is named or, in other words, if your estate is the beneficiary of the account, then the HSA and the account value shall be included on your final income tax return. The amount reported on your return cannot be reduced for the payment of any qualified medical expenses incurred by you and that your estate paid within a year of the date of your death. This is true even if your spouse is the sole beneficiary to your estate.
In conclusion, naming your spouse as the beneficiary of your HSA account carries numerous tax advantages. If you are not married, naming another person as the beneficiary of your HSA account is a good option, depending on the value of the account and the tax implications you might have if you named no beneficiary and had the value reported on your final income tax return.