Why HSAs Are Great for You, But Not Your Beneficiaries
By Net Worth Advisory Group
HSAs are powerful tax planning tools while you’re alive. Your contributions are deductible, funds in the account grow tax-free, and withdrawals for specific, qualified medical expenses are not typically taxed either.
While your HSA is great for retirement planning, it may pose some issues when it comes to legacy planning. Here’s a closer look at how your HSA could impact your beneficiaries and what you can do about it.
Spouses Receive the Best Treatment
This is the “cleanest” beneficiary scenario. Oftentimes if your spouse inherits your account, it simply becomes their HSA. They keep all of the account’s tax advantages as long as they use it for qualified medical expenses.
Non-Spouse Beneficiaries May Inherit a Tax Bill
What happens if you leave your HSA to someone other than your spouse, though? Unfortunately, when this happens, the account generally stops being an HSA. Instead, your beneficiary inherits the fair market value of the account. This is the case whether the beneficiary is an adult child, sibling, friend, or anyone else who is not your spouse.
Here’s why that’s a problem: when your beneficiary receives the fair market value of the account (usually in the same year as your death), it’s counted as taxable income. They may receive a surprise tax bill, and depending on their other sources of income, they may also jump a tax bracket.
Ultimately, an HSA might be one of the most tax-friendly accounts you own, but one of the least tax-friendly accounts your children inherit.
Beneficiary Designations Deserve Attention
As you think about the possible impacts of your HSA on your beneficiaries, you might ask yourself who you’ve left the account to. If you aren’t sure who your HSA beneficiary is, you aren’t alone.
Many people forget to designate beneficiaries on these accounts, but designating a beneficiary for your HSA matters just as much as it does on your IRA, your 401(k), or your life insurance policy.
Regularly reviewing your HSA beneficiary designation should be an ongoing part of your estate planning process. It’s particularly important to revisit your plan after major life events like these:
- Divorce
- Marriage
- Death of a spouse
- Remarriage
Even in the absence of significant life events, it’s typically a good idea to review your estate plan every three to five years.
Don’t make the mistake of failing to designate a beneficiary or accidentally making your estate a beneficiary. These might seem like minor errors, but they can significantly complicate your estate’s administration process.
Smart Planning Can Reduce the Problem
Fortunately, you don’t have to give up your HSA for the sake of your heirs. These planning ideas may help you reduce the problem:
- Rely on your HSA for qualified medical expenses, especially later on in your retirement.
- Keep all receipts for past medical expenses in case you want to reimburse yourself.
- Decide whether to spend your HSA before more tax-efficient assets.
- Ask an advisor if naming a charitable beneficiary may make sense.
There’s no singular best strategy for handling an HSA. The right one depends on your spouse, your heirs, your tax situation, and your health.
Need Help Managing and Understanding HSAs?
Legacy planning can be overwhelming, and it often involves coordinating multiple moving parts throughout your lifetime. Net Worth Advisory Group is here to help you build a financial future you can feel confident in.
As fee-only advisors, we don’t receive commissions, incentives, or kickbacks from selling you certain investment products. Our compensation only comes from you.
Call us at 801-566-6639 or schedule a complimentary, no-obligation consultation to see if we are a good fit to help you pursue your goals. To learn more, visit our website.
About Net Worth Advisory Group
Founded in 2003, Net Worth Advisory Group is a Salt Lake City-based, fee-only firm specializing in helping individuals transition smoothly into retirement without fear of outliving their assets. As a NAPFA-registered practice, the firm’s team of CFP® professionals operates under a strict fiduciary standard, offering objective, personalized wealth management free from product-commission conflicts. Through comprehensive financial mapping and disciplined semi-annual reviews, Net Worth Advisory Group is dedicated to bringing clients lasting financial confidence and the freedom to live the lives they have imagined.
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