Health Savings Account (HSA)

A Health Savings Account, or HSA, is a tax-advantaged account where individuals can invest funds to plan for future qualified medical expenses.

An HSA is an investment vehicle, just like a brokerage or IRA. An HSA owner can invest funds into the HSA by making tax-deductible contributions to the fund.

The funds in the HSA grow over time. Growth on the assets within the HSA is tax-free.

When the HSA owner needs to pay for insurance deductibles, coinsurance, copayments, or other qualified medical expenses, they can take a tax-free withdrawal from the HSA.

If the HSA owner withdraws funds from the HSA for any non-medical reason, they will be forced to pay a 20% penalty on the funds that are withdrawn.

When the HSA owner passes away, the funds in their HSA either go to their surviving spouse (if applicable) or to a designated beneficiary. In some unique situations, the funds in the HSA might go to the HSA owner’s estate or even to a revocable trust.

There are three main tax benefits to an HSA:

1. Contributions to an HSA are tax deductible.
2. Asset growth in an HSA is not taxable.
3. Withdrawals from an HSA are not taxable.

Now, that doesn’t mean that you can just donate thousands upon thousands of dollars to an HSA and deduct it from your taxes.

The IRS has established clear limits for funding HSA's. In 2023, for example, an individual can contribute $3,850 to an HSA for self-coverage. If an individual is funding the HSA for a family, that limit sits at $7,750 in 2023.

Although an HSA can be a beneficial investment tool, it is helpful to consider where the funds in an HSA will go upon the original account owner’s death.

When establishing an HSA, owners will be able to choose a designated beneficiary. 

If an HSA owner dies and their designated beneficiary is their surviving spouse, the surviving spouse can continue to treat the HSA as their own. In other words, the HSA will remain an HSA and can be used by the surviving spouse for qualified medical expenses.

If an HSA owner dies and their designated beneficiary is any individual who is not a surviving spouse, then the HSA immediately terminates. The designated beneficiary cannot treat the HSA as their own, and the funds in the account do not remain tax-free if used for qualified medical expenses.

Instead, any non-spouse beneficiary must treat the funds in the HSA as income. It’s no different than if the deceased individual had left them a large pile of cash in their will.

If an HSA has a named beneficiary, then the HSA will bypass the probate process upon the original owner’s death. The HSA will be treated like a payable-on-death account (POD) or transfer-on-death account(TOD) and go directly to the beneficiary.

It is rare to be able to establish an HSA without choosing a designated beneficiary, but there are situations where the original HSA owner might have overlooked the importance of naming an HSA beneficiary.

In that case, the HSA will not bypass probate.

Although the HSA will terminate upon the account owner’s death if there is no named beneficiary, the funds in the HSA will remain in the account owner’s estate. The funds will be treated as part of the taxable estate and will either transfer according to the deceased’s will or according to the intestacy laws of the deceased’s estate if the individual died intestate (without a will).

Because an HSA will go through probate if no beneficiary is named, it’s important for HSA owners to ensure that the HSA is set up with named beneficiaries.

The way that a Health Savings Account works depends upon the type of beneficiaries that are named:

Health Savings Account with a surviving spouse beneficiary

Franklin, a wealthy individual who lives in Anchorage, Alaska, passes away at the age of 94. Franklin’s wife, Suzanne, is still living at the time of Franklin’s death.

Franklin had previously set up an HSA and named his wife as the sole beneficiary of the HSA. Upon Franklin’s passing, the HSA transfers to Suzanne.

Because she is Franklin’s surviving spouse, Suzanne can continue to enjoy the benefits of the HSA. The assets in the HSA will continue to grow tax-free, and Suzanne can take any withdrawals from the account for insurance copayments, coinsurance, deductibles, or for other qualified medical expenses.

Health Savings Account with a non-spouse beneficiary

Klara, an 89 year old widower who lives in Omaha, Nebraska, passes away in early 2023. Klara had previously established an HSA and had named her son, Gerard, as the sole beneficiary of the account.

Because Gerard is a non-spouse beneficiary, the HSA terminates immediately upon Klara’s passing.

Gerard will receive the funds in the HSA, but he must report the funds as income and will be liable for income tax on the inheritance.

Health Savings Account with multiple non-spouse beneficiaries

Meghan, aged 102, is a widower living in Siler City, North Carolina. She passes away in 2023, leaving behind a large HSA that she set up many years ago.

The HSA has 4 designated beneficiaries—Phillip, Ruth, Rick, and Lanie—who are each set to receive 25% of the funds in the HSA.

Because the 4 designated beneficiaries are not surviving spouses, the HSA terminates when Meghan passes away. The 4 designated beneficiaries will not be able to enjoy the tax advantages of the HSA.

Philip, Ruth, Rick, and Lanie each receive their respective share of 25% of the HSA’s funds. They each must report the funds as income on their tax returns.