The tax benefits of contributing to a Health Savings Account 1(HSA), if you are covered by a high deductible health insurance plan, are significant due to their “triple tax advantage”2 nature. Here’s how it works:
Advantage #1: Contributions are federally tax-deductible. Most states (except California and New Jersey) also allow the deduction.
Advantage #2: Investments held in an HSA are free from federal income taxes. Most states also exempt the income from taxes.
Advantage #3: Withdrawals for qualified medical expenses are also tax free and do not have to be taken in the same year as the expense incurred. If you save the receipts, you can reimburse yourself at any time in the future for qualified medical expenses incurred once the HSA account is open.
Given these tax advantages, it is wise to invest the dollars in your HSA taking advantage of the tax-free growth. If you invested your HSA, it is likely you will end up with a significant account balance in later years you can use to cover your qualified medical expenses, over-the-counter medicines, and even some insurance premiums, if paid for long term care, COBRA coverage or Medicare premiums (excluding Medicare Supplemental). The IRS provides a comprehensive list of what’s considered a qualified medical expense: Publication 502 (2023), Medical and Dental Expenses | Internal Revenue Service.3
But what if you don’t spend it all? A strong argument could be made to wait as long as possible before reimbursing yourself from your HSA to maximize the tax-free growth component. However, not many folks want to focus on the administrative burden of HSA reimbursement on their deathbed. So, what happens if you are too successful in growing your account and do not fully empty the account prior to your death? The tax treatment of distributions from an HSA depends on who is the designated beneficiary4.
Naming Your Spouse as the Beneficiary is the most tax efficient transfer. The HSA avoids probate and can be converted to your spouse's own HSA. Your spouse can continue to use the HSA as if it were theirs, meaning they can withdraw funds tax-free for qualified medical expenses or continue to contribute if they meet the eligibility requirements.
Non-spouse beneficiary: The HSA is no longer tax advantaged. The account must be liquidated, and the entire balance is treated as taxable income to the beneficiary in the year of the account holder's death. However, if the beneficiary uses any of the funds for the deceased account holder's qualified medical expenses, those withdrawals will not be taxed if paid within one year. There is an exception to this rule: if the beneficiary is a charity, the account will be liquidated and paid to the charity tax-free.
If There is No Named Beneficiary – The Nuclear Option: The HSA is included on the deceased’s final tax return and the account balance is taxed as part of the estate. The account loses its tax-preferred status, meaning the estate will pay both income tax and potentially estate tax on the balance of the account. The account may also be subject to probate which may be costly in your state.5
Planning Tips for HSA’s
Health Savings Accounts are one of the easiest tax saving options included in your benefits. Please reach out to your financial advisor if you have any questions regarding tax benefits or how best to utilize the strategies mentioned in this article.
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Disclosures:
Apella Capital, LLC (“Apella”), DBA Apella Wealth is an investment advisory firm registered with the Securities and Exchange Commission. The firm only transacts business in states where it is properly registered or excluded or exempt from registration requirements. Registration with the SEC or any state securities authority does not imply a certain level of skill or training. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, product or any non-investment-related content made reference to directly or indirectly in this material will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may not be reflective of current opinions or positions. Please note the material is provided for educational and background use only. Diversification seeks to improve performance by spreading your investment dollars into various asset classes to add balance to your portfolio. Using this methodology, however, does not guarantee a profit or protection from loss in a declining market. Past performance does not guarantee future results. All data is from sources believed to be reliable but cannot be guaranteed or warranted.
No current or future client should assume that any discussion or information contained in this material serves as the receipt of, or as a substitute for, personalized investment advice. As with any investment strategy, there is the possibility of profitability as well as loss.
Apella Wealth does not provide insurance services or legal advice and nothing either stated or implied here should be inferred as providing such advice.
The information provided herein is general in nature. It is not intended, nor should it be construed, as legal or tax advice. Because the administration of an HSA is a taxpayer responsibility, you are strongly encouraged to consult your tax advisor before opening an HSA. You are also encouraged to review information available from the Internal Revenue Service (IRS) for taxpayers, which can be found on the IRS website at IRS.gov. You can find IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, and IRS Publication 502, Medical and Dental Expenses, online, or you can call the IRS to request a copy of each at 800-829-3676.