This Savings Account Is One Of The Worst Assets To Inherit

One of the most important aspects of estate planning is understanding the tax implications of inheritance, especially when savings accounts are involved. While assets like life insurance payouts are often transferable with little to no tax burden to heirs, the same can't be said for certain savings accounts. One such account is the Health Savings Account (HSA), which can be one of the worst assets to inherit if you're not legally married to the account holder.

Owners of these accounts are allowed to make tax-deductible contributions, enjoy tax-free growth of the investment, and withdraw distributions tax-free, provided they're funding qualified medical expenses. However, these tax benefits cannot be inherited by non-spousal beneficiaries. If the account owner passes away and the designated beneficiary isn't their spouse, the account immediately ceases to be an HSA. Instead, the assets are liquidated at fair market value and distributed to the designated beneficiary. Since this distribution is taxable in the year the deceased passes away, inheriting an HSA from someone you're not married to can leave you with a significant tax burden, especially if the distribution is large enough to change your federal tax bracket.

Although transferring an HSA to a non-spouse beneficiary remains a taxable situation, there are still several steps that account holders and beneficiaries can take to minimize tax consequences. From the account holder's perspective, the most effective course of action is to spend down their HSA while they're still alive. This reduces the value of the HSA, thereby minimizing the potential tax burden on a non-spousal beneficiary. Another proactive option available to account holders is designating a charitable organization as their beneficiary. This is a great way to not only avoid leaving your non-spouse beneficiary with a large tax bill, but also helps to put your health savings towards a good cause. While an HSA committed to a charitable organization will still be liquidated and distributed upon the account holder's death, it wouldn't be subject to same taxation because charities typically have tax-exempt status.

Beneficiaries have fewer tax mitigation options. The most viable workaround at their disposal is using the inherited HSA to cover any qualified medical bills left behind by the deceased. The legal basis for this is that the IRS allows non-spousal beneficiaries to reduce their taxable income by the amount used to cover qualified medical bills left behind by the deceased. If done correctly, and within 12 months of the account holder's passing, this can one of the best ways to avoid paying taxes on the full value of the HSA.