After death, is an HSA still an HSA?

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bnes
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After death, is an HSA still an HSA?

Post by bnes » Wed Jun 25, 2014 2:06 am

If funds are left in an HSA after death, the basis is stepped up.
What are the required distributions for the heirs? At that point is it still an 'HSA' or is it really a closet IRA?

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tadamsmar
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Re: After death, is an HSA still an HSA?

Post by tadamsmar » Wed Jun 25, 2014 2:35 am

bnes wrote:If funds are left in an HSA after death, the basis is stepped up.
What are the required distributions for the heirs? At that point is it still an 'HSA' or is it really a closet IRA?
If the heir is the spouse, it's the spouse's HSA. Otherwise, all the assets are reported as someone's income during the year of the death.

http://www.sterlinghsa.com/faq/death_of ... nt_holder/

Pub 629:

http://www.irs.gov/publications/p969/ar02.html

Says the HSA stops being an HSA at death if there is no beneficiary. Seems to mean that funds from the account can be used for tax-free withdrawals before death (if there are matching qualified expenses), but all withdrawals going to the estate after death are taxed as ordinary income.

In the early years of the HSA there seemed to be a rule that the executor could make tax-free withdrawals to cover qualified expenses, but apparently no more.

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Re: After death, is an HSA still an HSA?

Post by abuss368 » Wed Jul 02, 2014 12:46 pm

HSA's are still kind of new and evolving. It will be interesting to see how this plays out in the future. I like the overall concept and have an account however, I am still a little cautious of having a large balance at this time.
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hoppy08520
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Re: After death, is an HSA still an HSA?

Post by hoppy08520 » Wed Jul 02, 2014 7:23 pm

There are a couple of footnoted links with more information in the wiki:

http://www.bogleheads.org/wiki/Health_s ... erited_HSA

As abuss368 wrote, it's hard to find much information on these. Our own super expert Alan S. is one one of the posts and it seems a bit ambiguous to him as well.

Based on a worst-case reading of Pub 969, it seems that if you die then all your HSA money becomes taxable (to a non-spouse beneficiary), even if you had been stockpiling receipts for reimbursable expenses. I think all the super-Roth-IRA praise for HSAs should address this concern more, and explain draw-down strategies in light of this potential disadvantage.

To be very blunt about this, suppose you are unmarried and are getting up there in age and have a HSA that you are planning to bequeath to, say, your daughter. Suppose you're trying not to withdraw from the HSA so you can let it compound tax-free, which is what all these articles recommend. The minute your health takes a turn for the worse, you had better withdraw pretty fast from your HSA, just in case. And you had better hope you get a warning and don't just pass away in your sleep. Otherwise, your daughter will lose a lot of your HSA funds to taxes. Maybe you could have your withdrawal papers at the ready in an envelope with a postage stamp (make it a "forever" stamp just to be safe). On the way to the hospital, be sure to drop it in the mailbox. Sorry for the gallows humor, and if I'm misunderstanding the ramifications of this, please correct me.

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Re: After death, is an HSA still an HSA?

Post by Spirit Rider » Wed Jul 02, 2014 8:29 pm

Yes, this whole area of inheriting HSAs is a big gray area. Non-spouse beneficiaries are the ones with the biggest question mark, however spouse beneficiaries are not necessarily immune to this issue. Upon death it immediately becomes the inheriting spouse's HSA, but then it is no longer the decedent's HSA. Can the spouse distribute the undistributed expenses of the decedent. There is no clear guidance and even the experts are stumped.

This really needs guidance from the IRS. Short of this, it may need private letter rulings that you can at least follow with some sense you are on solid ground. At some point all these stealth IRAs are going to result in substantial balances being inherited with significant undistributed tax-free amounts. That means that people are going to have to leave money on the table, distribute the pending tax-free amounts and not claiming it as income, or seek private letter rulings. both of the latter two options will trigger a response from the IRS. Either they will agree or assess penalties and tax the distributions. Maybe it will eventually end up in Tax Court.

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Re: After death, is an HSA still an HSA?

Post by Retread » Wed Jul 02, 2014 8:40 pm

bnes wrote:If funds are left in an HSA after death, the basis is stepped up.
What makes you think the basis is stepped up? Isn't this an ordinary income asset which receives no change in basis as the result of death?
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Re: After death, is an HSA still an HSA?

Post by grabiner » Wed Jul 02, 2014 9:15 pm

Retread wrote:
bnes wrote:If funds are left in an HSA after death, the basis is stepped up.
What makes you think the basis is stepped up? Isn't this an ordinary income asset which receives no change in basis as the result of death?
An HSA doesn't have basis for federal tax purposes. However, in a state which does not recognize HSAs (AL, CA, NJ), an HSA is just a regular bank/mutual fund/brokerage account for state tax purposes, so it would get a stepped-up basis. Thus, if you die in CA with stock in your HSA, and the stocks are sold immediately, your beneficiary will not owe any CA capital gains tax.
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hoppy08520
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Re: After death, is an HSA still an HSA?

Post by hoppy08520 » Thu Jul 03, 2014 9:21 am

Thinking about this more, it occurs to me that maybe the fact that a HSA "ceases to be an HSA" after a non-spouse beneficiary inherits it is not that much of a big deal.

For example, suppose Dad has a $50,000 HSA, and he is sitting on $40,000 worth of unreimbursed medical expenses. Dad is widowed and is leaving everything to Son.

Scenario A: Dad reimburses himself for all $40,000 of medical expenses. He now has $40,000 in cash and $10,000 HSA balance. For Dad, this is not a taxable event, so this action does not affect his tax return (other than needing to record the distribution in his return).

Scenario B: Dad does not reimburse, so his $50K HSA stays as is.

Next, Dad dies.

Scenario A: Son inherits $40,000 in cash and a HSA that has a $10,000 value which becomes cash that counts toward income.

Scenario B: Son inherits a HSA that has a $50,000 value which becomes cash that counts toward income.

Dad's overall estate is less than estate tax exemption (which I believe is $5.34M in the USA). In both Scenario A and B, isn't the net-net that Son has a $50,000 inheritance in the form of cash that is tax exempt because it's under this threshold? Let's leave aside state estate taxes for a moment. Or, does the HSA balance become taxable income that falls outside the tax-exempt inheritance classification?

If the former, then my earlier statement that you should reimburse all your expenses on the way to the hospital doesn't really matter. Am I understanding this correctly, that the net-net of Scenario A and B are identical?

If the two scenarios are identical, then there really isn't any pressing need to reimburse yourself from your HSA before death. I think the only practical effect is that you should reimburse yourself from your HSA before taking anything out of a Roth IRA and before taking out any excess amounts from a traditional IRA beyond RMD. Given a choice, you'd rather leave $1 to your heirs in an IRA than $1 in a HSA because the latter will become ordinary cash while the former will stay in a tax-protected account. (Note that this was as point made in another thread by Spirit Rider, so all credit to him/her for this advice.)

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Re: After death, is an HSA still an HSA?

Post by Spirit Rider » Thu Jul 03, 2014 10:13 am

hoppy08520,

The problem in your scenario B is that the $50K is included as ordinary income to the beneficiary. Having a beneficiary means it passes outside the estate and is taxable to the beneficiary.

Scenario C: The beneficiary is the estate (designated or defaulted), the HSA becomes ordinary income of the estate. Ordinary income of an estate is not subject to estate tax, but rather subject to the estate's income tax return. Estates (and Trusts) have much steeper tax brackets and would be pay a high marginal rate on this income.

There are potential estate tax (and income with respect to the decedent) issues if the estate is large enough, but the income tax issues will hit everyone.

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hoppy08520
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Re: After death, is an HSA still an HSA?

Post by hoppy08520 » Thu Jul 03, 2014 11:16 am

Spirit Rider wrote:hoppy08520,

The problem in your scenario B is that the $50K is included as ordinary income to the beneficiary. Having a beneficiary means it passes outside the estate and is taxable to the beneficiary.
Spirit Rider, thanks for the clarification! (underline emphasis added by me) I get it now. Clearly this means that Scenario A (reimburse from HSA) is in fact better.

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Re: After death, is an HSA still an HSA?

Post by GOAT » Thu Jan 08, 2015 7:02 pm

As a related question, is it possible to list a spouse as the primary beneficiary of an HSA (hopefully the HSA withdrawals will continue to be non-taxed) and list a family limited partnership, IRA inheritance trust, or other trust as the contingent beneficiary to keep the money out of the estate for asset protection and estate tax purposes in regards to the children of the couple?

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BL
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Re: After death, is an HSA still an HSA?

Post by BL » Thu Jan 08, 2015 7:32 pm

I had a small HSA that I recently withdrew tax-free to pay for previously received Medicare Part B.
It can be set up to pay regular Medicare amounts in the future. I think the other health insurance payments would work the same. It makes sense to me to start using it as soon as you need to withdraw any non-RMD money. Spouse automatically is heir, I named secondary heirs as well, but it would be more like IRA money there and they would have to pay immediate taxes, AFAIK.

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Re: After death, is an HSA still an HSA?

Post by alaskantraveler » Thu Jul 14, 2016 5:17 pm

Yes there is a downside to dying before spending all the funds in an HSA and non spouse inheriting the HSA and having to claim it as income. In the example above. After death the HSA becomes a tax advantaged account to the beneficiary that must be claimed as income in the same year. Not an ideal situation tax situation for the beneficiary, but not so great of an issue that I wouldn't take advantage of the $6750/ yr max contribution for family. That for me is tax deductible on the way in and no taxed on the way out. That is the best retirement account there is as long as you're still living.

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Re: After death, is an HSA still an HSA?

Post by Artsdoctor » Thu Jul 14, 2016 8:47 pm

On one hand, a non-spouse beneficiary will get something. Depending on the size of the HSA, the tax bite could be small or large, depending on the income of the non-spouse beneficiary.

On the other hand, it would seem like a waste. It's possible that the balance could be easily six digits and the beneficiary could already be making a nice income, so a large chunk would just be squandered in federal (and perhaps state) income taxes.

In life (and the life of the spouse), it's a great investment vehicle. In death, not so much.

If you leave a charity as the contingent beneficiary, the whole amount is maintained and is transferred directly to the charity of your choice, tax-free.

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tadamsmar
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Re: After death, is an HSA still an HSA?

Post by tadamsmar » Sun Jul 24, 2016 6:28 pm

"The amount taxable to a beneficiary other than the estate is reduced by any qualified medical expenses for the decedent that are paid by the beneficiary within 1 year after the date of death."

https://www.irs.gov/publications/p969/a ... 1000204096

Looks like your HSA is still (sort of) your HSA after death if you name a beneficiary and if the beneficiary has your qualified unpaid medical bills.

But I am not sure of all the tax implications.

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Re: After death, is an HSA still an HSA?

Post by sesq » Mon Jul 25, 2016 1:40 pm

I am using the HSA as a "stealth" IRA. However, due to the short circuit caused by a non-spousal inheritance I am planning to use it as the first account to draw against. I am an amputee and incur substantial out of pocket expenses. I log/save receipts and expect even with growth I should have a substantial percentage of my funds saved available as tax free reimbursements of prior expenses. My log does not differentiate whose medical expense is being reimbursed (all people are covered in family HDHP), so I guess the question about whether reimbursement would be available for past expenses is available if my wife was to inherit the HSA is a good one. Once I exhaust my reimbursement amounts I plan to use the HSA funds on the current qualifying expenses. Ideally I'd prefer to use these balances up before tapping my tax deferred balances, which would be next, followed by my Roth balances last (absent an extraordinary expense where I am trying to manage my tax brackets but need cash). In my model, assuming an early retirement I should exhaust the HSA by 69 or so.

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Re: After death, is an HSA still an HSA?

Post by michaeljc70 » Mon Jul 25, 2016 2:31 pm

abuss368 wrote:HSA's are still kind of new and evolving. It will be interesting to see how this plays out in the future. I like the overall concept and have an account however, I am still a little cautious of having a large balance at this time.
I also have a large balance (never used it for medical expenses,invested in stocks). However, I plan to use it in retirement for medical expenses. You can use them after age 65 to pay Medicare Part A,B and D premiums.

You can also use it for anything after age 65, but you''d have to pay the tax. So, if I don't think I can use it all for medical expenses, I will use that before any other retirement accounts (excepting RMDs).

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Re: After death, is an HSA still an HSA?

Post by Artsdoctor » Mon Jul 25, 2016 3:05 pm

michaeljc70 wrote:
abuss368 wrote:HSA's are still kind of new and evolving. It will be interesting to see how this plays out in the future. I like the overall concept and have an account however, I am still a little cautious of having a large balance at this time.
I also have a large balance (never used it for medical expenses,invested in stocks). However, I plan to use it in retirement for medical expenses. You can use them after age 65 to pay Medicare Part A,B and D premiums.

You can also use it for anything after age 65, but you''d have to pay the tax. So, if I don't think I can use it all for medical expenses, I will use that before any other retirement accounts (excepting RMDs).
Don't forget that you can also use it to reimburse yourself for expenses which were paid out of pocket while the HSA plan was in place. This applies even if it was many years earlier (as long as you have the receipts).

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Re: After death, is an HSA still an HSA?

Post by ryman554 » Mon Jul 25, 2016 4:09 pm

Artsdoctor wrote:
michaeljc70 wrote:
abuss368 wrote:HSA's are still kind of new and evolving. It will be interesting to see how this plays out in the future. I like the overall concept and have an account however, I am still a little cautious of having a large balance at this time.
I also have a large balance (never used it for medical expenses,invested in stocks). However, I plan to use it in retirement for medical expenses. You can use them after age 65 to pay Medicare Part A,B and D premiums.

You can also use it for anything after age 65, but you''d have to pay the tax. So, if I don't think I can use it all for medical expenses, I will use that before any other retirement accounts (excepting RMDs).
Don't forget that you can also use it to reimburse yourself for expenses which were paid out of pocket while the HSA plan was in place. This applies even if it was many years earlier (as long as you have the receipts).
I personally wouldn't count on that option being available in the long-term, given the (off-topic) chatter about closing IRA tax loopholes.

Back to the OP, don't I seem to recall that the estate is allowed to pay for medical expenses for the deceased in the year (year after?) of death? I know that the beneficiary designation messes this up a bit, but I would not be surprised to see something similar being clarified.

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Re: After death, is an HSA still an HSA?

Post by Artsdoctor » Mon Jul 25, 2016 7:10 pm

^ Most people would be loathe to make financial decisions based on what "might" happen in the future. I'm not quite sure what IRA loophole would be analagous to an HSA reimbursement.

HSA funds can be used to pay for medical expenses of the deceased account holder's that haven't already been paid for up to one year after death.

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Re: After death, is an HSA still an HSA?

Post by ryman554 » Tue Jul 26, 2016 8:43 am

Artsdoctor wrote:^ Most people would be loathe to make financial decisions based on what "might" happen in the future. I'm not quite sure what IRA loophole would be analagous to an HSA reimbursement.

HSA funds can be used to pay for medical expenses of the deceased account holder's that haven't already been paid for up to one year after death.
We are really straying far into danger zone regarding proposed laws, but I'll risk a reply: The statement above was implying that the chatter about closing the roth conversion loophole for high earners may also mean the HSA gets a second look, too.

The loophole closure for the HSA would be to simply disallow any deductibility of medical reimbursements older than one (tax?) year -- to maintain the spirit of the HSA vs. turning it into another investment vehicle. That changes significantly the calculus of cash-flowing medical expenses vs. hoarding them until death. No question we have to play by the rules today, which favor getting growth into the HSA and cash-flowing existing medical expenses, but I think there is a non-zero likelihood of something like this change happening in the future.

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Re: After death, is an HSA still an HSA?

Post by Artsdoctor » Tue Jul 26, 2016 6:18 pm

^ I'm not sure I understand the loophole issue here.

The law doesn't say that you're required to pay for your medical expenses from the HSA in the year that they're incurred.

Medical cost during retirement is a very big wild card. I don't think it's a loophole to save for future medical expenses when you're going to be most vulnerable--after the work income has ceased. I never really thought that I was pushing the limits of the law when I started saving in my Health Savings Account, and the IRS publications are very, very clear on how reimbursements can be made--either in current time or retroactively.

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Re: After death, is an HSA still an HSA?

Post by ryman554 » Wed Jul 27, 2016 8:49 am

Artsdoctor wrote:^ I'm not sure I understand the loophole issue here.

The law doesn't say that you're required to pay for your medical expenses from the HSA in the year that they're incurred.

Medical cost during retirement is a very big wild card. I don't think it's a loophole to save for future medical expenses when you're going to be most vulnerable--after the work income has ceased. I never really thought that I was pushing the limits of the law when I started saving in my Health Savings Account, and the IRS publications are very, very clear on how reimbursements can be made--either in current time or retroactively.
I never said otherwise.

What I said is that I would be reasonably surprised if, in 10-20 years, the statement above would still be true. To me, that changes my HSA calculus.

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