Maximize the Legacy of Your Health Savings Account

The main benefits of a health savings account (HSA) are delivered during your lifetime. But an HSA also can build a legacy, and so it should be carefully considered as part of your estate plan.

An HSA is not a use-it-or-lose-it account. You can name a beneficiary to inherit the account.

When you don’t name a beneficiary or name your estate as beneficiary, the HSA is distributed to your estate. The account will stop being an HSA and the entire account balance will be included in gross income on your tax return for the year of your death.

When your spouse is the beneficiary, the account will remain an HSA, and your spouse will be its new owner. Distributions will continue to be tax free when they pay or reimburse qualified medical expenses for your spouse and his or her dependents.

The surviving spouse also can take tax-free distributions to the extent either of you paid or incurred unreimbursed medical expenses in the past.

Distributions to pay for expenses other than qualified medical expenses will be taxed to the surviving spouse the same as distributions from a traditional IRA.

When the beneficiary is an individual other than your spouse, the account stops being an HSA on the date of your death. The account balance is distributed to the beneficiary or converted to a taxable account for the beneficiary. In either case, the account balance on the date of your death is included in the beneficiary’s gross income as are any income or gains earned after your passing.

But any unreimbursed qualified medical expenses you incurred and that the beneficiary pays within one year of your death reduce the taxable amount.

That creates an opportunity for taxes on the inherited HSA to be substantially reduced and perhaps eliminated.

Of course, the beneficiary can reimburse the estate for any reimbursed medical expenses incurred just before you passed.

But the IRS rules don’t say the reimbursable expenses are limited to those incurred shortly before your death.

A strict reading of the tax code indicates the beneficiary can pay your estate for reimbursed expenses incurred by you at any time and use that amount to reduce the taxable amount of the HSA. The beneficiary or other heirs then would inherit the payments tax free through the estate, according to the terms of your will.

Keep a good record of the qualified medical expenses you paid that weren’t reimbursed by insurance, the HSA, or any other source. Be sure your executor knows where to find those records. Then, the executor can give the records to the HSA beneficiary.

IRS rules aren’t clear whether the reimbursements must be for only medical bills that were outstanding at the time of your death or can be for medical expenses you paid previously that weren’t reimbursed. Because the IRS guidance isn’t explicit, this should be considered an aggressive tax strategy.

An alternative way to spare your heirs taxes on the inherited HSA would be to name either your revocable living trust or estate as the beneficiary. I don’t recommend this strategy with IRAs, but it can be a good strategy for HSAs. The income taxes would be paid by your estate or the trust instead of the beneficiary.

Another option is to name a charity as the HSA beneficiary. Let your family members inherit other assets that aren’t taxable and make your charitable bequests using an HSA. The charity won’t be taxed on the HSA balance.

Another way to build a legacy with HSAs is to ask your children about their use of HSAs.

Suppose an adult child qualifies for an HSA because he or she is covered by a high-deductible medical insurance policy, but the child’s employer doesn’t contribute the maximum amount to the HSA. The child doesn’t have the cash flow to fully fund the account.

You can make contributions to the HSA for the child as part of your estate planning gifts. Total contributions to the HSA for the year from all sources can’t exceed the annual limit. The contribution counts toward your annual gift tax exclusion amount, which is $18,000 in 2024. You won’t be able to deduct the contribution because the HSA isn’t covering you or a dependent. Or you can give the cash to the child, who can contribute it to the HSA and deduct the contribution on his or her tax return.

You’ve helped create a tax-free balance for your child. The child can invest the account and let the balance compound over the years. Or the balance can be used to pay family medical expenses the child can’t pay from current income.