If you're enrolled in a qualified high-deductible health plan (HDHP), you must consider how your health savings account (HSA) fits into your estate plan—especially to make sure that any hard-earned money left in your HSA when you die goes where you want it.
What is an HSA?
An HSA is an account whose funds may be used to pay for qualified medical expenses or saved for expenses that arise in the future. These accounts have several tax advantages. You can deduct contributions to the account up to the yearly limit. You pay no income taxes on earnings in the account (such as interest or dividends). And, withdrawals from the account to pay for qualified medical expenses are tax-free. An HSA is an option for any one enrolled in a qualified HDHP. Your insurer will be able to tell you if you have a qualified HDHP.
Unused HSA funds may be carried over into the following year, which is in sharp contrast to a flexible spending account (FSA), whose funds are considered “use it or lose it,” because you can only carry over up to $500 from one year to the next, as long as your plan allows for the carry over.
An HSA functions as a bank account plus investment account fusion while you're alive but gets treated more like a retirement account at your death—and this dichotomy makes strategic estate planning that considers all tax ramifications crucial.
Estate Planning with HSAs
How you approach estate planning with your HSA depends largely on your account goals. There are two broad categories of people with HSAs. They are:
- Accumulators may use HSA funds for medical expenses, but their overriding intention is to build up a balance year after year and use the HSA as a supplement to retirement funds.
- Spenders use HSA funds to pay for qualified medical expenses tax free and their overriding intention is to save income taxes each year by running their qualified medical spending through the account.
Both accumulators and spenders should be concerned with directing where HSA funds should go after death, but contacting an estate planner is an immediate must for accumulators because of the potentially large sums of money and tax issues involved. Without a plan in place, your HSA balance may pass to your heirs through probate, the court-supervised process of distributing a deceased person's estate. Probate can take several months or years and add extra expenses for your estate on top of the income tax bill.
The easiest way to avoid probate for your HSA is to designate a beneficiary to receive the funds upon your death. Many people name a spouse as a beneficiary. A surviving spouse who receives an HSA can continue to treat the funds as an HSA, allowing the spouse to continue to defer taxes and use the money for qualified health expenses.
You may also choose to name a non-spouse beneficiary, perhaps because you are unmarried or have children from a previous marriage. For non-spouse beneficiaries, the account will cease being an HSA upon your death, the HSA fair market value becomes taxable income to the beneficiary in the year of your death, and the account balance (less income taxes) is distributed to your named beneficiaries.
Another option is to name a trust as the beneficiary of your account. This can be a particularly good option if you would like to leave the funds to a minor. If you leave the account to a trust, the HSA amount becomes taxable income on your final income tax return, and funds pass to the trust for the benefit of the beneficiary. For minor beneficiaries, this avoids costly guardianship proceedings for the minor's inheritance. For other beneficiaries, a trust may offer better asset protection, divorce protection, and privacy than leaving the account outright.
Your family can pay your medical bills out of the account within a year of the death. Depending on your other assets, paying final medical bills out of the HSA can result in significant savings. If a loved one has passed away and had an HSA, it's always a good idea to obtain a professional opinion before paying the deceased's medical bills.
Overall, HSAs can be extremely useful tools in retirement, tax planning, and estate planning, but the tax rules surrounding them are complex. To maximize your benefits and do what's best for you and your loved ones, call our offices for a consultation today.