Health Savings Accounts (HSAs) have grown increasingly popular over the last two decades, helping many individuals and families save for current and future healthcare expenses.

Yet, these accounts are often viewed as healthcare spending tools, rather than long-term savings vehicles. The reality is that a Health Savings Account can represent a meaningful asset, making it important to understand what happens to those funds when the account owner passes away.

The answer largely depends on who inherits the account.

Why HSAs Can Be So Valuable

Before discussing inheritance rules, it’s worth understanding why many financial planners encourage clients to maximize their HSA contributions.

While you’re working, an HSA can be a great triple-threat savings option. We often describe it as a “medical 401(k).” Contributions may be tax-deductible, investments can grow tax-free, and withdrawals for qualified medical expenses are generally tax-free. Few accounts offer all three benefits.

An HSA can also serve as a long-term savings vehicle for future healthcare costs. For those who can afford it, we recommend paying current medical expenses out of pocket, allowing their HSA assets to remain invested and continue growing tax-free.

Eventually, HSA funds can be used for a variety of healthcare-related expenses, including Medicare premiums, deductibles, copays, COBRA continuation coverage, and other qualified medical expenses. A portion can also be used for long-term care premiums, up to $6,200 per person, per year, based on age*.

One often-overlooked advantage of this approach is the ability to reimburse prior medical expenses. As long as you incurred qualified medical expenses after establishing your HSA and kept proper records, you may be able to reimburse yourself years later. This creates flexibility that many people don’t realize they have. By saving receipts and allowing HSA dollars to remain invested, some savers are able to build a larger pool of tax-advantaged funds for future healthcare needs.

While HSAs offer significant benefits during your lifetime, the rules can change considerably once the account passes to a beneficiary.

If Your Spouse Is the Beneficiary

The most favorable outcome occurs when a spouse is named as the beneficiary.

When an HSA passes to a surviving spouse, the account simply becomes the spouse’s HSA. The tax advantages remain intact, and the surviving spouse can continue using the account for qualified medical expenses just as the original owner did.

There is generally no immediate tax consequence for the surviving spouse, and the account retains its HSA status.

For married couples, naming a spouse as a beneficiary often provides the greatest amount of flexibility and tax efficiency.

If Someone Other Than Your Spouse Inherits the HSA

The rules change significantly when the beneficiary is someone other than a spouse.

If an adult child, sibling, other family member, or friend inherits the account, the HSA ceases to be an HSA as of the owner’s death. The beneficiary does not receive an inherited HSA that can continue to grow tax-free.

Instead, the value of the account generally becomes taxable income to the beneficiary in the year of death.

This is where many people are surprised.

For example, if an adult child inherits an HSA worth $30,000, that amount may be included in the child’s taxable income. The beneficiary cannot continue using the account tax-free for future medical expenses, as a spouse can.

In some cases, qualified medical expenses incurred by the account owner before death may reduce the amount ultimately subject to tax. Because the rules can be complex, beneficiaries should consult with a qualified tax professional or financial advisor regarding their specific situation.

In practice, the inherited account is often treated more like an inherited retirement account distribution than as an ongoing HSA. Even if the beneficiary ultimately uses the funds for medical expenses, the favorable HSA treatment generally no longer applies, and the distribution is generally taxable as ordinary income.

What If Your Estate Is the Beneficiary?

If no beneficiary is named, or if the estate is named as the beneficiary, the HSA’s value is generally included as income on the deceased account owner’s final income tax return.

This can create additional tax complexity and may result in less favorable treatment than naming an individual beneficiary.

As with retirement accounts and life insurance policies, beneficiary designations warrant periodic review. An outdated beneficiary form can lead to unintended outcomes and unnecessary complications for loved ones.

What if You Leave Your HSA to Charity?

There is another beneficiary option worth considering for individuals who have charitable goals.

Unlike a non-spouse individual beneficiary, a qualified charity can receive HSA assets without creating income tax consequences. Because charitable organizations are generally tax-exempt, the funds can pass to the charity without the tax burden that may apply when the account is inherited by family members or other individuals.

As with any estate planning strategy, the right approach depends on your goals, beneficiaries, and overall financial situation.

Key Takeaways

HSAs can be powerful savings vehicles during your working years and throughout retirement. They offer unique tax advantages and help cover a wide range of healthcare expenses later in life.

However, the treatment of an HSA after death depends largely on who inherits the account:

• A surviving spouse can generally continue the account as their own HSA.
• Non-spouse beneficiaries generally recognize the account value as taxable income.
• Naming your estate may create less favorable tax treatment.
• A qualified charity may be able to receive HSA assets without income tax consequences.
• Beneficiary designations should be reviewed regularly as part of your overall estate plan.

Like many aspects of financial planning, a little preparation today can make life easier for your loved ones tomorrow.

Questions About Your HSA?

Whether you’re deciding how to invest your HSA, reviewing beneficiary designations, or considering how your HSA fits into your broader retirement and estate plans, the advisors at EKS Associates can help.

If you have questions about your Health Savings Account or would like a second opinion on your planning strategy, contact EKS Associates to schedule a conversation.

*The $6,200 limit is accurate at the time of publication and is subject to change annually. Always confirm numbers with your financial advisor before making any decisions.