A recent article from the Inside Indiana Business website discussed the advantages of utilizing a health savings account ("HSA") as a retirement savings vehicle. The article noted that an HSA allows for tax-deductible contributions, tax-free growth, and tax-free distributions. As a result of these income tax advantages and the increased use of HSAs by employees participating in employer-provided high deductible health plans, HSAs are bound to become a significant asset in the investment portfolios of many individuals. From an estate-planning standpoint, it has become increasingly important to coordinate HSAs with the owner’s estate plan.
Similar to 401(k) and individual retirement accounts, HSAs pass at death to the beneficiary designated by the account owner on the applicable beneficiary designation document. The owner's choice of who is named as the beneficiary can have a substantial impact on the treatment of the account going forward. For instance:
- If the owner's estate is the beneficiary, then the account stops being an HSA upon the owner’s death. As a result, the account’s fair market value is includable in the deceased owner’s gross income on his or her final personal income tax return.
- If a non-spouse individual is the named beneficiary, the account stops being an HSA and its fair market value becomes includable in the named beneficiary’s gross income in the year of the original owner's death. Thus, for an unmarried HSA owner, it may be advantageous for him or her to purposefully use the HSA during his or her lifetime, and if possible, instead transfer other assets to the intended beneficiaries.
- The negative income tax outcomes can be avoided for married couples if the HSA owner simply designates his or her spouse as the primary beneficiary of the account. It should come as no surprise that, similar to 401(k) and individual retirement accounts, a spouse who is designated as the primary beneficiary of an HSA will be treated as if he or she is the original owner of that account. In other words, the owner's death will be a non-event from an income tax perspective.
As with other accounts in an individual’s investment portfolio, it is important to coordinate health savings accounts into the owner's overall estate plan to ensure that it is transferred according to his or her wishes and in an efficient manner to the beneficiaries.