Podcast Episode 461: Inherited HSAs: Are You Leaving Behind a “Tax Time Bomb”?
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Health savings accounts (HSAs) can be one of the most tax-advantaged tools to pay for medical expenses in retirement. However, they can also create an unexpected tax burden when passed to the next generation. The good news is that with simple adjustments, you can turn a hidden tax trap into a long-term advantage.
In this episode of Money Wisdom, Nicholas J. Colantuono, CFP® and Eric Hogarth, CFP® break down how HSAs fit into a tax-efficient retirement strategy.
What is an HSA?
An HSA allows you to save money on a tax-advantaged basis for future medical expenses. Contributions are tax-deductible and the money grows tax deferred. As long as you use withdrawals for qualified medical expenses, they’re completely tax-free. Because of their triple-tax advantaged nature, it’s clear why HSAs have become increasingly popular.
However, leaving a large HSA balance behind can create a significant tax obligation for your heirs. Many retirees want to leave an inheritance, but doing so in the most tax-efficient way possible is key. Fortunately, there are strategies that can help avoid an impending tax time bomb.
Want clarity about your tax situation? Get your free Taxes Simplified guide by texting “OFFER” to 800-757-0436.
What Are the Inherited HSA Rules?
If you pass away and leave your HSA to your spouse, they can continue using the account for their own qualified medical expenses. But if you leave it to a non-spouse like a child or grandchild, the HSA beneficiary rules are vastly different.
In this scenario, the account loses its tax-advantaged status. Therefore, it becomes taxable income for your beneficiaries in the year of your death. Your beneficiaries must then fully distribute the account within the required period.
How Can You Avoid Creating a Tax Time Bomb?
Unless you’re leaving your HSA to a surviving spouse, you likely want to avoid passing it down as an inheritance. If you have a substantial balance remaining, there are a few strategies to consider. One of the easiest solutions is to spend it on qualified medical expenses. Routine healthcare costs such as doctor visits and prescriptions are exactly what HSAs are meant for.
You could also spread the inheritance among multiple beneficiaries, which could reduce the overall tax impact. If you leave behind any unpaid medical expenses, your beneficiary can use the account to pay them within 12 months of your death.
Even with the current rules, don’t hesitate to contribute to an HSA if you’re eligible. Once you’re retired and medical expenses arise, use the money—that’s exactly what it’s there for.
