Health savings accounts are a powerful wealth accumulation vehicle. They are one of the few account types with a triple tax benefit — tax-free paycheck deferrals, no taxes on account growth and no taxes on withdrawals for qualified medical expenses.
But there are potential tax pitfalls to avoid when using HSAs, especially for aging clients who have well-funded accounts but not a lot of time to use them. Surviving spouses have some flexibility in inheriting HSAs, but the funds will count toward the income of most other inheritors.
The result can be a hefty tax bill for the inheritor, one that many don’t expect given the HSA’s general tax benefits.
This dynamic is explored by financial planning experts Jeff Levine and Ed Slott in the latest episode of their podcast series, "The Great Retirement Debate." During the episode, Levine and Slott consider the pros and cons of HSAs.
The duo encourage those who are participating in high-deductible health care plans to consider putting as much as possible into an HSA. For those who don’t need the funds right away or who have built up a decent account value, investing the funds also makes sense.
But it’s also important to be aware of the tax consequences when a client passes away with HSA assets, Levine and Slott emphasized.
Surviving Spouses and HSAs
As Levine and Slott explored, upon the death of an HSA holder, any amounts remaining in the HSA transfer to the beneficiary named on the HSA beneficiary designation form. If a beneficiary is not named, the funds transfer according to the terms of the HSA trust or custodial account agreement.
