Where Does Your Health Savings Account Go When You Pass Away?
By William G. (Bill) Stuart | Originally posted here
Your Health Savings Account doesn't die when you do. But what happens to it when you're no longer alive?
Health Savings Accounts don't die when their owners do, and the balances don't disappear. They're distributed to some person or entity. The account owner has control over who receives the balance, and the tax treatment depends on the beneficiary's relationship to the owner at the time of the owner's death. Let's examine the options that an account owner has in choosing a beneficiary and the tax implications of each choice.
Trust Law
Health Savings Accounts are trusts. And although they're regulated almost exclusively by federal tax law, they are governed by state law in some important areas. One such area is treatment of the balance of the trust upon death. (Two other areas, by the way, are protection from bankruptcy and escheatment.) In most states, a trust isn't established until the person establishing the trust signals an intent to do so (such as signing a trust agreement), names a beneficiary to assume ownership of the trust upon his death, and places something of value into the trust.
Thus, in most cases, a Health Savings Account owner names a beneficiary at the beginning of the process. If that doesn't happen, the account provider usually informs the owner regularly of the need to do so.
Your Spouse as Beneficiary
When you name your spouse as beneficiary, the account is transferred to her upon your death. Because it's a trust, it bypasses probate. She needs to complete some paperwork to have the balance transferred to her Health Savings Account (if she previously opened one) or to open an account to receive the balance. She does not need to be eligible to open and fund an account to receive your balance.
This is the most tax-efficient transfer of account balances. The tax advantages remain in place as the balance is transferred to a spouse. Your spouse doesn't have to be HSA-eligible to open her own account and receive the funds. If she is eligible to contribute, the transfer doesn't affect her annual contribution limit (though your death may move her from a family to a self-only contract, which would reduce her funding to half the family ceiling for all future months).
She can reimburse tax-free her own and her tax dependents' qualified expenses. And if she remarries, she can reimburse tax-free her new spouse's (and her spouse's tax dependents') qualified expense tax free if the expenses were incurred on or after their wedding date.
Someone Else as Beneficiary
But you're not limited to naming your spouse as beneficiary. You can name a child, a friend, a charity, or even a pet to receive the balance of your account upon your death. In that case, the Health Savings Account is liquidated and the proceeds given directly to your beneficiary (or beneficiaries - you can have more than one).
This approach isn't as tax efficient as naming a spouse, as the distribution is taxable income to the recipient. On the other hand, your twenty-something child may prefer to receive unrestricted funds - even taxable money - that she can spend on any item without penalty. After all, she may have few medical expenses but be servicing student- or auto-loan debt, or saving to purchase a home or business. She'd rather have spendable cash than money that's tax-protected and penalty-free only when spent on qualified expenses.
No One as Beneficiary
You may not have completed your beneficiary paperwork, or your beneficiary predeceased you (or can't be found upon your death), or your beneficiary for some reason refuses the bequest. What then?
It's often said that everyone has an estate plan. The only distinction is whether it's written by the person prior to his death or by the laws of the state in which the estate is settled. With no beneficiary to whom the funds can pass from a trust, the balance is distributed according to the estate plan in place.
The Bottom Line
You control who receives your Health Savings Account balances upon your death. If you're happily married, the choice is easy - you maximize the value of the account by naming your spouse as beneficiary. If you're not married (or not in a blissful union), you can name anyone else, though the account is liquidated and the tax benefits end. As with all planning of the distribution of your assets upon your death, it's always better for your loved ones if you - rather than your state legislature - craft your estate plan.
I'm director of strategy and compliance at Benefit Strategies, LLC, an administrator of Health Savings Accounts and reimbursement accounts. You can read and subscribe to my Health Savings Account GPS blog here and read my weekly HSA Monday Mythbuster and HSA Wednesday Wisdom columns and occasional Healthcare Update column published on LinkedIn. My book, HSAs: The Tax-Perfect Retirement Account, is the definitive guide to navigating the intersection of Health Savings Accounts, retirement planning, and Medicare. It's available in paperback and e-book at Amazon.