What to Consider When Choosing an HSA Beneficiary
Health Savings Account (HSA) owners can choose to name their spouse, adult children, other individuals, or a trust as their beneficiary. If no beneficiary is named, the HSA will be distributed to the estate.
Careful consideration should be made when choosing a beneficiary as there are different tax implications depending on who is listed, or not listed, as the beneficiary of the HSA. It is also important to note that some states require spousal consent if the accountholder wishes to name someone other than their spouse.
When the employee’s spouse is named as the beneficiary, the account can remain a an HSA and the spouse can continue to take advantage of all that the HSA offers. They may make contributions to the account (if they are otherwise eligible to do so), earn interest tax-free and use the account for their own healthcare expenses without any tax consequences. If they choose to use the account for expenses that are not health-related, they will be required to pay income tax on those amounts and an additional 20% penalty if they are under age 65.
When an individual or group other than the employee’s spouse is named as the HSA beneficiary, the funds must be distributed and taxed at the fair market value of the account on the date of the employee’s death. Each beneficiary will pay taxes at their own income tax rate. If the money is invested, the account can make gains between the time of the account holder’s death and the closing of the account. These gains would be taxed like any other capital gains.
When a trust (revocable or irrevocable) is named as the HSA beneficiary, the fair market value of the account will be included on the employee’s final tax return. This may be the best option if your chosen beneficiary is a minor. We recommend seeking professional tax advice due to the complexity of trust accounts.
When no beneficiary is named, the HSA ends on the date of the accountholder’s death. The fair market value of the account will be included on the employee’s final income tax return and the HSA will be distributed to the estate (even if there is a surviving spouse). Another downside to this is that when requesting distribution of the HSA, the estate will need to provide additional documentation confirming the identity of the executor of the estate in the form of a small estate affidavit, a letter from an attorney, or a document from the court.
In any of these cases, the funds may be used for the health expenses that were incurred by the deceased accountholder for up to one year following their death.