If you have an HSA, you should think about what happens to your account after your death. The rules are a little tricky and careful planning is important to minimize the tax bite for HSA beneficiaries.
You should name a beneficiary for your HSA the same way you would for an IRA or company retirement plan. After your death, any funds remaining in the HSA are payable to the named beneficiary. (It’s also important to remember the beneficiary doesn’t have to be your spouse and they don’t have to be eligible to make HSA contributions.)
Naming Your Spouse
If you name your spouse beneficiary, at your death the HSA becomes your spouse’s HSA. They can maintain the HSA in their own name and continue to access funds. Distributions for qualified medical expenses are income tax free. Also, your spouse doesn’t need to have HSA-eligible health insurance to continue to hold the HSA. However, if they do and they are eligible, they may make contributions to the HSA.
Naming Your Children
You may also name your children (or other non-spouse individual) beneficiary. However, you should be aware the account value of your HSA becomes taxable to any non-spouse beneficiary in the year of your death. That means the entire account will be taxable in one year. However, your beneficiary can reduce the taxable amount by paying for your qualified medical expenses from the account within one year after the date of your death.
If you’re in a low tax bracket and your child is in a high tax bracket, it may make sense for you to name your estate as the beneficiary instead of your child.
Naming Your Estate
It is also possible to name your estate beneficiary. If an estate is beneficiary, the total distribution amount is in included on your final tax return. Again, if you’re in a lower tax bracket that your child, it may make sense to name your estate beneficiary.