Health savings accounts’ triple tax advantage make them one of the most powerful savings vehicles for old age, but they can also end up blowing up your heir’s taxes if you plan to leave unspent money to a non-spouse, advisers said.
Since HSAs are medical savings accounts meant to help individuals with High-Deductible Health Plans save for current and future out-of-pocket health care expenses, they don’t follow the same rules as other savings vehicles like brokerage and retirement accounts after death.
Depending on who inherits the HSA, it could lose its tax-advantage status. All the leftover money would become taxable income to the beneficiary at once – the year you die.
“We’ve trained clients to maximize HSAs – fund medical expenses out of pocket, contribute to HSAs and invest and grow it,” said Jaime Eckels, partner in Plante Moran Wealth Management. “Now, they have to be trained that it’s time to tap into it.”
What Happens to an HSA When You Die?
When a spouse inherits the HSA, it remains active and the spouse assumes ownership without consequences. The spouse can make tax-free withdrawals for qualified medical expenses, just as the deceased spouse did.
If the beneficiary is anyone else, the HSA loses its tax-advantaged status the day you die. The account is closed, and the total fair-market value of the funds, less any unpaid qualified medical expenses the HSA is used to pay within a year of your death, becomes taxable income to the beneficiary for that year. There’s no step-up basis like in a brokerage account or 10 years to empty an inherited retirement account to spread out taxes.
Non-spouse beneficiaries become even more relevant considering the increasing number of widows and widowers and people who choose to remain single, advisers said.
More than half a million men and more than a million women were widowed in America in 2022, according to the U.S. Census Bureau.
Separately, more than 15 million adults ages 55 and older, or about 16.5% of the population, were childless in 2018, a U.S. Census Bureau report released in 2021 said. From 2018 to 2023, the share of adults under 50 who said they were unlikely to ever have children also rose to 47% from 37%, a survey of more than 2,500 adults by the nonprofit Pew Research Center showed.
Why HSAs Are Still Worth Using
Despite potential drawbacks upon death, HSAs remain a favorite savings vehicle among financial advisers because contributions are tax-free, money grows tax-free and if used for a qualifying expense, withdrawals are tax-free. Companies can also contribute to an employee’s HSA.
There’s no expiration date on when you can withdraw funds for qualified medical expenses you’ve already incurred, as long as the account was active at the time. So if you’ve been paying medical bills out-of-pocket for years and saved your receipts, you can withdraw that exact amount as a reimbursement from your HSA tax-free at any time – even use those funds for a vacation or to make a large purchase.
“Think of the HSA as a piggy bank for medical expenses that can grow similar to an Individual Retirement Account,” said Richard Pon, certified public accountant in San Francisco.
At the end of 2024, 39.3 million HSAs existed that helped cover more than 59.3 million Americans, according to a survey by HSA consultant Devenir and the American Bankers Association’s Health Savings Account Council.
President Donald Trump’s signature tax and spending plan passed last summer also opened HSAs to tens of millions more Americans by allowing more Affordable Care Act insurance plans, Direct Primary Care arrangements and plans with telehealth coverage to qualify.
How to Defuse the HSA Tax Bomb
Those with large HSA balances should whittle them down and plan how to distribute the remainder, advisers said. Options retirees might consider include:
- Use tax-free HSA funds to pay medical expenses. HSAs can be used to pay Medicare premiums, long-term care premiums and dental and vision bills, for example.
- Use unreimbursed medical receipts from prior years to withdraw as much tax-free money as possible. Once the money’s out, you can use it for a large purchase or even invest it into a brokerage account or something else that can pass to a beneficiary with fewer tax consequences, Eckels said.
- If you plan to name beneficiaries, consider who they are, how much they earn and where they live, said Derek Miser, investment advisor and chief executive at Miser Wealth Partners. “Understanding those dynamics can be a way to split up tax burden,” he said. For instance, you may not want to leave a sizable HSA to a high earner living in a state with high state and local taxes.
- If a potential heir is in a high tax bracket but you aren’t, withdraw some HSA money and pay the taxes if you don’t have enough unreimbursed medical expense receipts to make tax-free withdrawals. “Once you’re over 65 (years old), you can use the money for nonmedical expenses and not pay the withdrawal penalty, but you pay the taxes,” Eckels said. If your tax rate is low, it may be worth it to save your heir from a tax hit.
- Naming a charity or donor advised fund (DAF) as the beneficiary lets the money pass tax-free, Miser said. A DAF provides added flexibility because the money can be distributed over time and to different charities, he said.
Whatever you do, always name a beneficiary, Eckels said. Without one, the HSA will be taxed to the deceased person on the last tax return and won’t be able to be used to pay final medical expenses billed after death, she said.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at [email protected] and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday.
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