A Health Savings Account (HSA) owner may designate any person or nonindividual, including his/her estate, as the death beneficiary of his/her HSA. The rules that determine what happens to an HSA after an account owner’s death are easy to understand. Unlike the rules that govern individual retirement accounts (IRAs), which may allow a beneficiary multiple distribution options, HSA rules predetermine what happens to an HSA based on the beneficiary’s relationship to the account owner. Let’s look at the rules for a spouse, a nonspouse, and an estate beneficiary.
If a deceased HSA owner’s spouse is the death beneficiary, the inherited HSA becomes the spouse’s own HSA as of the account owner’s date of death, whether the spouse is covered under a high deductible health plan (a requirement to make HSA regular contributions) or not. From a procedural standpoint, a common approach taken by some HSA custodians and trustees when moving assets from a decedent’s name and social security number to a surviving spouse’s name and social security number, is to establish an HSA for the surviving spouse and transfer the balance of the decedent’s HSA to that of the surviving spouse.
Because a surviving spouse is not recognized as an ongoing beneficiary after the death of an HSA owner, a surviving spouse will never take a death distribution. Distributions taken by a spouse after an account owner’s date of death are normal distributions, taken from what is now his/her own HSA. A spouse may take tax-free distributions from the HSA to pay for his/her own qualified medical expenses, or those of dependents or the deceased account owner.
If a nonspouse is the death beneficiary of an HSA the account is no longer an HSA as of the account owner’s date of death, essentially resulting in an immediate taxable distribution from a tax standpoint. The beneficiary must include the HSA’s date-of-death fair market value (FMV) as taxable income in the year of the account owner’s death. However, because the distribution is due to death, the 20 percent penalty tax, which applies to nonqualified distributions, does not apply. Additionally, any portion of an inherited HSA balance used to pay outstanding medical expenses of the account owner within one year of the account owner’s death will not be taxable to the beneficiary.
Estate as beneficiary
If an HSA owner’s estate is the death beneficiary, the HSA is no longer an HSA as of the date of death. The FMV of the HSA as of the account owner’s date of death is included in the HSA owner’s year of death gross income.
IRS reporting after death
Financial organizations are responsible for properly reporting contributions and distributions to an HSA owner and the IRS. Additionally, distribution reporting for a nonspouse and estate beneficiary are required and explained below.
HSA Owner (decedent): IRS Form 5498-SA, HSA, Archer MSA, or Medicare Advantage MSA Information, reports contributions made on behalf of an HSA owner prior to his/her death. If no contributions were made, it appears as if there should be a final Form 5498-SA in the decedent’s name reporting a zero FMV. Distributions taken by an HSA owner prior to his/her death are reported on IRS Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA, in the decedent’s name and social security number.
Spouse beneficiary: Because account ownership of an HSA is considered to be that of a surviving spouse upon the death of an HSA owner, death distribution reporting is not possible in a surviving spouse’s name and social security number. Distributions taken by a surviving spouse after an HSA owner’s death are reported as normal distributions on Form 1099-SA in the spouse’s name and social security number. Form 5498-SA will be generated under the new HSA owner’s name as necessary.
Nonspouse beneficiary: For the year of death, an HSA custodian/trustee should generate Form 1099-SA in the name and social security number of the beneficiary. Box 1 reports the amount distributed and Box 4 reports the date of death value. Due to accrual of earnings between the date of death and the date of distribution those two amounts may be different.
Because an HSA is no longer considered an HSA as of the account owner’s date of death, a nonspouse beneficiary will not receive a Form 5498-SA to report the end-of-year FMV.
Estate: The reporting guidance is not clear, however, an HSA custodian or trustee should generate Form 1099-SA in either the estate’s name or decedent’s name and the respective identification number.
The HSA death rules are very straight forward with the HSA owner/beneficiary relationship determining what happens to an HSA upon an account owner’s death. An HSA custodian or trustee is responsible for proper account maintenance and reporting after the death of an HSA owner, and should have procedures in place for each type of beneficiary. It is up to an HSA custodian or trustee to determine how it will handle HSAs upon the death of account owners.
Further information relating to HSAs can be found in IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, which is available at irs.gov. Additionally, HSA reporting guidance is available in the Instructions for Forms 1099-SA and 5498-SA at irs.gov.
For an opportunity to learn more about IRAs and other tax-advantaged accounts including Health Savings Accounts and Coverdell Education Savings Accounts, consider our on-demand video training offered on a variety of topics. Go here to learn more about training opportunities available to you, or call us at 1-800-552-9408.