Health Savings Accounts (H.S.A.s) are powerful tools, particularly if you participate in a high deductible health insurance plan. H.S.A.s are essentially tax-exempt accounts to fund certain medical costs you may incur. You may deduct contributions you or an individual other than your employer makes to your H.S.A. on your behalf. A deduction for H.S.A. contributions is available to you even if you do not itemize your deductions on your return. Furthermore, your employer may also make contributions to your account. In this case, your employer’s contributions are excluded from your income. You may use distributions from your account tax-free for qualifying medical expenses. Any unused funds roll over from year-to-year. Additionally, all interest and investment earnings to your H.S.A. are tax-free. You may now be familiar with the benefits of your H.S.A. while you are alive, but do you know what would happen to your H.S.A. when you die? Where do the funds go? What are the tax consequences? In essence, the fate of your H.S.A. funds will be determined based on whom you designate as the beneficiary.
Spouse as a Beneficiary
A spouse is the most commonly designated beneficiary. When your spouse inherits your H.S.A. on the date of your death, the account will retain its character and legally become theirs. This transfer does not require your spouse to have an H.S.A. eligible health insurance policy. Moreover, your spouse will be able to utilize the funds to pay for medical expenses; including long term care premiums. In other words, the provisions of the H.S.A. will apply to your spouse as they had applied to you. In addition, once your spouse turns 65, account assets can be used for any type of expense without incurring a 20% penalty on the distribution. The particular expense does not have to be medically related. With that being said, it may be most advantageous for your spouse not to access the inherited H.S.A. funds until they reach the age of 65.
Non-Spouse Beneficiary you designate an individual who is not your spouse as the beneficiary, the H.S.A. classification of the account funds terminates upon transfer. The fair market value of the H.S.A. at your date of death becomes taxable to the beneficiary. The taxable amount will be reduced by any qualified medical expenses the beneficiary had paid for you within one year of your death.
Estate as a Beneficiary
You also have the option to designate your estate as a beneficiary. If you do not designate a beneficiary, your estate automatically becomes the beneficiary. In this case, the fair value of your H.S.A. will be reported on your final 1040. You will be able to take advantage of tax savings in the form of a deduction for estate taxes paid on the value of your H.S.A. included in your taxable estate.
In summary, you must consider all outcomes carefully when you complete your beneficiary form for your H.S.A. If you do designate a beneficiary, ensure they also understand the applicable tax implications when they receive the funds. To receive more information regarding H.S.A.s including limits and timing of contributions; please feel free to contact one of our knowledgeable tax advisors.
