HSA Planning: Drawdown and Estate Planning

The IRS recently announced the annual HSA contribution limits for 2024: $4,150 for self-only coverage and $8,300 for family coverage. This is one of the most significant jumps in years and not surprising, given the latest inflation trends. And if you are 55 or older, you can tack on an additional $1000 catch-up contribution. What this means is that for those individuals who are 55 and over, a single person can potentially contribute $5,150 and a couple can contribute $10,300 per year.

As wealth advisors, this is music to our ears. We often advise clients to maximize their HSA contributions, pay for ongoing medical expenses with outside funds, and then invest the balance of their HSA for long-term growth. This is because an HSA is the only savings vehicle that offers the triple threat of tax-deductible contributions, tax-deferred growth, and tax-free withdrawals for qualified distributions. If an investor starts early, they can build a significant HSA portfolio. You might be hesitant to accumulate such a balance in your HSA, so let’s take a deeper look at this.

According to the Fidelity Retiree Health Care Cost Estimate, an age 65 retired couple in 2022 is projected to need approximately $315,000 in after-tax dollars to cover health care expenses. In retirement, you inevitably will encounter health care expenses that you have not considered. Things like Medicare premiums, multiple expensive prescriptions, vision care, hearing aids, wheelchairs, walkers, and even a portion of the premiums for long-term care policies (limitations based on age) can be covered with HSA distributions. When you take these distributions, it is not considered taxable income, which is a nice benefit in retirement.

Say you pass away unexpectedly with a significant balance in your HSA. The funds in your HSA will go to your named beneficiary when you die. If there is no beneficiary listed on your account, the funds will be distributed to your estate and the value will be fully taxable on your final income tax return. This is true even if you are married and forget to list your spouse. Always make sure you keep your beneficiary designations up to date!

However, if you name your living spouse as the sole beneficiary of your HSA, the account will avoid probate and be transferred directly to your spouse. He or she will continue to have all the benefits of the HSA, including continuing to have tax-free withdrawals for qualified healthcare expenses. This is the best way to continue to maximize the tax benefits and is usually the ideal course of action. If your spouse is under age 65 and chooses to withdraw funds from the account for non-qualified expenses, he or she will pay a penalty of 20%, in addition to income tax on the amount withdrawn. After age 65, there is no penalty, but they will still be responsible for the income tax on the amount withdrawn.

If you designate a beneficiary other than your spouse, the account will avoid probate, but will not transfer to the beneficiary in the same way that it does with a spouse. In this case, the account will be closed on the date of your death. And unlike other types of retirement accounts, the beneficiary is not given 10 years to stretch out taxable distributions. They will receive and pay taxes on the amount accumulated in the HSA in the original account holder’s year of death. This may not be the most ideal tax scenario. It could potentially push the beneficiary’s marginal income tax bracket higher. The beneficiary can take qualified HSA distributions to pay the original account owner’s medical expenses incurred within a year of the owner’s death.

So, for this reason, you want to continually evaluate the balance in your HSA and your beneficiary designations as you age. Particularly if you do not have a spousal beneficiary, try to take tax-free distributions for medical expenses during your lifetime whenever possible. If you have kept good records, take distributions for old medical expenses that you have not taken yet. And if you plan to leave any portion of your assets to a charity, your HSA is a good funding source since the charity will receive the donation with no tax liability.

If you have questions and would like to talk with us further, please call us at 513-271-6777. For more THOR reading, click here to go to the Blogs and Market Updates section on our website.