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Heatlh savings accounts have a 3x tax advantage, making them one of the most powerful savings tools for retirement, but leaving money you can’t spend to someone other than your spouse could also blow your heirs’ taxes, advisers said.
Because HSAs are health savings accounts intended to help individuals enrolled in high-deductible health plans save for current and future out-of-pocket medical expenses, they are not subject to the same rules as other savings vehicles, such as brokerage accounts or postmortem retirement accounts.
Depending on who inherits your HSA, you may lose the tax benefits. Any remaining money becomes taxable income to your beneficiary all at once in the year of your death.
“We’ve trained our clients to maximize their HSAs: cover their medical expenses out-of-pocket, contribute to their HSAs, invest and grow them,” said Jaime Eckels, partner at Plante Moran Wealth Management. “Now they have to be trained that it’s time to take advantage of it.”
What are the HSA succession rules if someone dies?
When a spouse inherits an HSA, the HSA remains active and the spouse assumes ownership without any consequences. Spouses, like deceased spouses, can withdraw qualified medical expenses tax-free.
If the beneficiary is someone else, the HSA loses its tax-advantaged status on the day you die. The account is closed and the total fair market value of the funds, less any unreimbursed qualified medical expenses used by the HSA to pay within one year after death, becomes the beneficiary’s taxable income for that year. There’s no step-up basis like a brokerage account or 10 years to empty an inherited retirement account to spread out taxes.
Non-spouse beneficiaries have become even more important given the growing number of widows, widowers and people choosing to remain single, advisers said.
According to the U.S. Census Bureau, more than 500,000 men and more than 1 million women will be widowed in the United States in 2022.
Separately, according to a 2021 U.S. Census Bureau report, more than 15 million adults over the age of 55 (about 16.5% of the population) did not have children in 2018. The percentage of adults under 50 who say they are unlikely to have children increased from 37% to 47% from 2018 to 2023, according to a survey of more than 2,500 adults by the nonprofit Pew Research Center.
Is an HSA worth using?
Despite the potential disadvantages upon death, HSAs remain a popular savings vehicle among financial advisors. That’s because contributions are tax-free, funds grow tax-free, and withdrawals are tax-free if used for qualified expenses. Companies can also contribute to their employees’ HSAs.
There is no expiration date during which you can withdraw funds for eligible medical expenses you have already incurred, as long as your account is active at that time. So if you’ve been paying out-of-pocket medical expenses for years and saving your receipts, you can always withdraw that money from your HSA tax-free as a refund, and you can even use the funds for a vacation or a big purchase.
“Think of an HSA as a savings bank for medical expenses that can grow, similar to an individual retirement account,” said Richard Pong, a certified public accountant in San Francisco.
There were 39.3 million HSAs in existence at the end of 2024, covering more than 59.3 million Americans, according to a study by HSA consultants DeVenir and the American Bankers Association’s Health Savings Account Council.
President Donald Trump’s signature tax and spending plan passed last summer made HSAs available to tens of millions more Americans by allowing them to qualify for more Affordable Care Act insurance plans, direct primary care arrangements, and plans with telehealth coverage.
Can people avoid the ticking HSA tax time bomb?
Companies with large HSA balances should reduce them and plan how to distribute the remainder, the advisers said. Options retirees can consider include:
- Use tax-free HSA funds to pay for medical expenses. HSAs can be used to pay for Medicare premiums, long-term care insurance premiums, and dental and vision bills, for example.
- Use unpaid medical receipts from the past few years to withdraw as much tax-free funds as possible. When you run out of money, Eckels said you can use it to make big purchases or invest it in a brokerage account or something else to pass it on to your beneficiaries with a lower tax burden.
- Derek Mizer, investment advisor and chief executive officer of Mizer Wealth Partners, said when naming beneficiaries, you need to consider who they are, how much they earn and where they live. “Understanding these dynamics can be a way to divide the tax burden,” he said. For example, you may not want to leave a large HSA for a high-income earner who lives in a state with high state and local taxes.
- If your potential heirs are owed a high tax bill but you are not, and you don’t have enough receipts for unpaid medical expenses to withdraw tax-free, withdraw the money in your HSA and pay the taxes. “Once you’re over 65, you can use that money for non-medical expenses and you don’t have to pay the withdrawal penalty, but you do pay taxes,” Eckels said. If your tax rate is low, it may be worth protecting your heirs from the tax burden.
- Miser said funds can be passed through tax-free by naming a charity or donor-advised fund (DAF) as the beneficiary. DAFs offer more flexibility because they can distribute funds to different charities over time, he said.
Whatever you do, always name the beneficiary, Eckels says. Without this, the HSA would be taxed on the deceased person’s last tax return and would not be available to pay for final medical expenses billed after death, she said.
Medora Lee is USA TODAY’s money, markets and personal finance reporter. Please contact us at mjlee@usatoday.com. Subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday.
