What Happens to an HSA upon Death

Question:  What happens to an HSA upon the HSA holder’s death?

Short Answer: The HSA will preserve its tax-advantaged HSA status if the beneficiary is a spouse, otherwise the account will lose its tax-advantaged HSA status.

General Rule: HSA Designed Beneficiary

HSAs permit the HSA holder to designate a beneficiary to receive the account’s funds upon the HSA holder’s death.

If the HSA holder fails to designate a beneficiary, the HSA will generally pass to the HSA holder’s estate.

Spouse is the HSA Beneficiary

If the HSA holder designates a spouse as the HSA beneficiary, the HSA passes to the spouse without change upon the HSA holder’s death.

The spouse will take over the HSA without any taxation, and the HSA will preserve the same tax-advantaged status as an HSA for the spouse.  In other words, the HSA will remain an HSA for the spouse in the same manner it was for the HSA holder.

Any Individual Other than Spouse is the HSA Beneficiary

If the HSA holder designates any individual other than a spouse as the beneficiary (e.g., domestic partner or children), the HSA will lose its tax-advantaged status upon the HSA holder’s death.

This means that the account ceases to be an HSA, and the fair market value of the account becomes taxable to the beneficiary in the year of the HSA holder’s death.

The non-spouse beneficiary can reduce the taxable amount by any payments made by the beneficiary for the HSA holder’s qualifying medical expenses incurred prior to the HSA holder’s death.  Such payments must be made by the beneficiary within one year of the HSA holder’s date of death to qualify for the reduction.

Estate is the HSA Beneficiary

If the beneficiary is the HSA holder’s estate (whether by designation or default), the HSA loses its tax-advantaged status and ceases to be a HSA upon the HSA holder’s death.

In this case, the fair market value of the HSA upon death is included in the HSA holder’s taxable income for the deceased HSA holder’s final tax return.

For more details on everything HSA, see our ABD Office Hours Webinar: Go All the Way With HSA.

Regulations

IRS Publication 969:

https://www.irs.gov/pub/irs-pdf/p969.pdf

Death of HSA Holder

You should choose a beneficiary when you set up your HSA. What happens to that HSA when you die depends on whom you designate as the beneficiary.

Spouse is the designated beneficiary.

If your spouse is the designated beneficiary of your HSA, it will be treated as your spouse’s HSA after your death.

Spouse isn’t the designated beneficiary.

If your spouse isn’t the designated beneficiary of your HSA:

  • The account stops being an HSA, and
  • The fair market value of the HSA becomes taxable to the beneficiary in the year in which you die.

If your estate is the beneficiary, the value is included on your final income tax return.

The amount taxable to a beneficiary other than the estate is reduced by any qualified medical expenses for the decedent that are paid by the beneficiary within 1 year after the date of death.

IRS Notice 2004-2, Q/A-31:

https://www.irs.gov/pub/irs-drop/n-04-2.pdf

Q-31. What are the income tax consequences after the HSA account beneficiary’s death?

A-31. Upon death, any balance remaining in the account beneficiary’s HSA becomes the property of the individual named in the HSA instrument as the beneficiary of the account. If the account beneficiary’s surviving spouse is the named beneficiary of the HSA, the HSA becomes the HSA of the surviving spouse. The surviving spouse is subject to income tax only to the extent distributions from the HSA are not used for qualified medical expenses.

If, by reason of the death of the account beneficiary, the HSA passes to a person other than the account beneficiary’s surviving spouse, the HSA ceases to be an HSA as of the date of the account beneficiary’s death, and the person is required to include in gross income the fair market value of the HSA assets as of the date of death. For such a person (except the decedent’s estate), the includable amount is reduced by any payments from the HSA made for the decedent’s qualified medical expenses, if paid within one year after death.

IRC §223(f)(8):

(8) Treatment after death of account beneficiary.

(A)  Treatment if designated beneficiary is spouse. If the account beneficiary’s surviving spouse acquires such beneficiary’s interest in a health savings account by reason of being the designated beneficiary of such account at the death of the account beneficiary, such health savings account shall be treated as if the spouse were the account beneficiary.

(B)  Other cases.

(i)  In general. If, by reason of the death of the account beneficiary, any person acquires the account beneficiary’s interest in a health savings account in a case to which subparagraph (A) does not apply—

(I)  such account shall cease to be a health savings account as of the date of death, and

(II)  an amount equal to the fair market value of the assets in such account on such date shall be includible if such person is not the estate of such beneficiary, in such person’s gross income for the taxable year which includes such date, or if such person is the estate of such beneficiary, in such beneficiary’s gross income for the last taxable year of such beneficiary.

(ii)  Special rules.

(I)  Reduction of inclusion for predeath expenses. The amount includible in gross income under clause (i) by any person (other than the estate) shall be reduced by the amount of qualified medical expenses which were incurred by the decedent before the date of the decedent’s death and paid by such person within 1 year after such date.

(II)  Deduction for estate taxes. An appropriate deduction shall be allowed under section 691(c) to any person (other than the decedent or the decedent’s spouse) with respect to amounts included in gross income under clause (i) by such person.

 

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship.  Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).

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