A Health Savings Account (HSA) is a popular, tax-advantaged option within high-deductible health plans, allowing you to set aside pre-tax money for qualified medical expenses. Not only are contributions tax-deductible, but earnings and withdrawals are also tax-free.

But what happens to that money after you’re gone? How do you use legacy planning to ensure your HSA goes to the right people? In this week’s Money Wisdom Question Series, Jake Doser, CFP®, CPWA® shines a light on this critical “triple tax-advantaged” retirement asset.

When an HSA is Left to a Spouse

The most effective way to ensure your HSA is passed on to the right person is by designating a beneficiary. If you name your spouse as the beneficiary, the transition is pretty straightforward: the HSA becomes theirs, and they can continue using the funds as if it were their own account. The same tax advantages apply, meaning withdrawals remain tax-free as long as they’re used for qualified medical expenses, including Medicare premiums and other eligible healthcare costs.

When an HSA is Left to a Non-Spouse

Where things become more complicated is if you leave your HSA to a non-spouse beneficiary, such as a child, parent, or sibling. In this case, the account is no longer considered nor functions as an HSA. Instead, the money in that account becomes a taxable distribution in the year in which you pass away. The beneficiary must report the full amount as ordinary income and pay any necessary taxes.

When to Explore Options Outside an HSA

While the money is inherited either way, leaving your HSA to a non-spouse beneficiary can raise serious concern from a tax planning perspective, as it can result in an unexpected and potentially significant tax bill. If you’re not planning to leave your HSA to a spouse, it may be worth considering alternative ways to pass on your wealth, such as through investment or savings accounts that offer a more favorable tax treatment for your heirs.

The bottom line: Make sure you have a clear financial plan in place. Understand how your accounts are taxed, the order in which withdrawals will be taken, and how those decisions will affect the people you leave behind.