HSAs: Understanding The Health Savings And Estate Planning Benefits

Adler Pollock & Sheehan P.C.
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Adler Pollock & Sheehan P.C.

In addition to serving as a viable option to reduce health care costs, a Health Savings Account (HSA) can positively affect your estate plan because its funds grow on a tax-deferred basis. An HSA is similar to a traditional IRA or 401(k) plan in that it’s a tax-advantaged savings account funded with pretax dollars. Funds can be withdrawn tax-free to pay for a wide range of qualified medical expenses.

ABCs of an HSA

To provide these benefits, an HSA must be coupled with a high-deductible health plan (HDHP). For 2020, an HDHP is a plan with a minimum deductible of $1,400 ($2,800 for family coverage) and maximum out-of-pocket expenses of $6,900 ($13,800 for family coverage). A recent benefit of HDHPs is that they can cover the costs of coronavirus (COVID-19) testing and treatment before deductibles are met without risking the plan’s status as an HDHP. In addition, plan participants who have HSAs may continue contributing to their existing accounts.

Another requirement for HSA contributions it that you not be enrolled in Medicare or covered by any non-HDHP insurance (a spouse’s plan, for example). Once you enroll in Medicare, you’re no longer eligible for an HSA, although you may still make contributions for the time you were eligible before going on Medicare. You may, however, continue to withdraw funds to pay for qualified expenses, and the list of qualified expenses expands when you turn age 65.

Currently, the annual contribution limit for HSAs is $3,550 for individuals with self-only coverage and $7,100 for individuals with family coverage. If you’re 55 or older, you can add another $1,000. Contributions may be made by you or your employer, although the limit is a combined limit, not a payer limit. Thus, if your limit is $7,100 and your employer contributes $5,000, you may add only $2,100.

Cost savings benefits

HSAs can lower health care costs in two ways: by reducing your insurance expense (HDHP premiums are substantially lower than those of other plans) and allowing you to pay qualified expenses with pretax dollars.

In addition, any funds remaining in an HSA may be carried over from year to year, continuing to grow on a tax-deferred basis indefinitely. When you turn 65, you can withdraw funds penalty-free for any purpose (although funds that aren’t used for qualified medical expenses are taxable).

To the extent that HSA funds aren’t used to pay for qualified medical expenses, they behave much like an IRA or a 401(k) plan.

Estate planning benefits

Except for funds used to pay qualified medical expenses, an HSA’s account balance continues to grow on a tax-deferred basis indefinitely, providing additional assets for your heirs. The tax implications of inheriting an HSA differ substantially depending on who receives it, so it’s important to consider your beneficiary designation.

If you name your spouse as beneficiary, the inherited HSA will be treated as his or her own HSA. That means your spouse can allow the account to continue growing and withdraw funds tax-free for his or her own qualified medical expenses. If you name your child or someone else other than your spouse as beneficiary, the HSA terminates, and your beneficiary is taxed on the account’s fair market value. Note, however, that any of your qualified medical expenses paid with HSA funds within one year after death aren’t taxable to the HSA beneficiary.

What if your estate is the beneficiary of the HSA? The full amount of the HSA is taxed to you in the year of death. Depending on your situation (for instance, if you’re in a low tax bracket and the beneficiary is in a high tax bracket) it may be a good tax planning strategy, or (if you’re in a high tax bracket and your beneficiary is in a low tax bracket) it could be a bad idea tax-wise. As with most tax planning issues, be sure to consider the various factors when making a decision.

The next steps

Opening and contributing to an HSA offers a tax-advantaged options that can help reduce health care costs and provide estate planning benefits. Contact your estate planning advisor for additional details.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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