Inheriting an HSA? Here's What You Need to Know Now

Three wooden blocks that spell "HSA" are on a bright green background. Their shadows spell out "Health Savings Account." — (Image credit: Getty Images with Gemini Edits)

There's a reason health savings accounts (HSAs) are often hailed as one of the best financial tools out there. Many people are used to enjoying the tax savings that come with traditional and Roth retirement plan contributions. HSAs combine those benefits into a single account that’s loaded with flexibility.

HSA contributions are tax-deductible (or made pre-tax through payroll), and you can invest unused funds tax-free. Withdrawals used for qualified medical expenses are tax-free, too. And at age 65, penalties for non-medical HSA withdrawals disappear. At that point, an HSA can double as a traditional IRA or 401(k), where withdrawals are taxable but can be taken for any purpose.

While an HSA can be beneficial during your lifetime, it's not always an ideal account to pass along to heirs.

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Spouses can still reap the benefits

Inheriting an HSA remains advantageous if it's your spouse’s account.

"The good news is that for a spouse who inherits an HSA, it keeps being an HSA," says Evan Mills, financial adviser at Scholar Advising. "They can use it for their qualified medical expenses, exactly the way it's designed."

Susan Einberger, CFP and owner of Enjoy the Ride: Financial + Life Planning, says taking over an HSA as a spouse is simple.

"The surviving spouse completes tax form 8889 as though the HSA belonged to them," she explains.

Non-spouse beneficiaries can face tax headaches

Just as inheriting an IRA can come with rules, the same is true with an HSA. But an HSA may come with more tax consequences.

"A non-spouse heir doesn't really inherit an HSA," says Mills. "They inherit the value of the account and potentially the income [tax] bill that comes along with it, and that's a big distinction."

Unlike an inherited traditional or Roth IRA, a non-spouse beneficiary cannot roll over or maintain the tax-advantaged status of an inherited HSA. Rather, the fair market value of the HSA upon the original owner's death becomes taxable to whoever inherits it.

The silver lining? While the distribution is taxed as ordinary income, the IRS waives the standard 20% penalty for non-qualified HSA withdrawals when the distribution occurs because the account owner died.

Still, "depending on the value of the HSA, this could affect the beneficiary's tax bracket and eligibility for certain deductions and credits," Einberger warns.

Estates and trusts

Mills says that if the HSA goes to an estate, the account's value will be included in the owner’s final income tax return. If a trust is the beneficiary, "the value will generally be taxable to the trust (although that income may ultimately be passed on to the beneficiaries of the trust)," Mills explains.

There's a way to offset the tax liability

If you inherit an HSA as a non-spouse, you're not automatically stuck with a gigantic tax bill.

"Within a year of the date of death, you're able to pay the original owner’s medical bills through the HSA," says Mills. "So before paying the tax bill on the HSA, check the original owner's medical bills for any expenses that occurred before death. That's another good way to drain that HSA account before getting hit with a major tax bill."

That one-year timeline could potentially give you a reprieve. But if the original account holder doesn’t have organized records, that could end up being more of a hassle than expected.

Be careful when managing multiple inherited accounts

If you inherit both an IRA and an HSA at the same time, you'll need to be mindful of different rules. With an IRA, you have up to 10 years to drain the account, whereas an HSA requires more immediate action.

If you can't find medical expenses from the original account holder to offset your HSA tax bill, you may want to hold off on withdrawals from an inherited traditional IRA to avoid increasing your tax liability.

However, if the owner of the IRA passed away at an age when they were already taking required minimum distributions (RMDs), you must also take an RMD each year. In that case, you may get stuck with a larger tax bill after all.

On the other hand, if you inherit a Roth IRA, the 10-year rule still applies. And it can be advantageous to let that account grow tax-free for 10 years and then take a lump-sum withdrawal at the end of that period. However, if you’re on the hook for a big tax bill due to inheriting an HSA, you could withdraw from an inherited Roth tax-free to cover that expense.

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Summary of HSA inheritance rules
HSA Feature	Spouse Beneficiary	Non-Spouse Beneficiary	No Designated Beneficiary (Estate)
Can Remain as an HSA?	Yes. The account continues as an HSA and becomes the surviving spouse's own account.	No.	No. The account is absorbed into the probate estate.
Tax on Inheritance	None. Transfer is tax-free.	Ordinary income tax on the account's full fair market value (FMV) as of the date of death.	Ordinary income tax on the account's full fair market value (FMV), reported on the owner's final individual income tax return.
When It Is Taxed	When taking non-qualified distributions in the future.	In the year of the original owner's death (no 10-year stretch rule).	In the year of death, on the owner’s final return (Form 1040).
20% Early Withdrawal Penalty	No. Normal HSA rules apply (penalty waived if aged 65+ or disabled).	No.	No.
Rollover / Transfer Allowed?	Yes. Can be rolled over or transferred directly into the surviving spouse’s existing HSA.	No. No rollovers or transfers to Roth IRAs.	No.
Medical Expense Deductions	Ongoing qualified medical expenses for the survivor, dependents, or deceased spouse can be paid tax-free.	Taxable amount is reduced dollar-for-dollar by the deceased’s unpaid qualified medical bills incurred before death, if paid by the heir within 1 year of death.	Taxable amount on the final return is reduced by the deceased’s medical bills incurred before death and paid by the estate within 1 year of death.
New Contributions Allowed?	Yes, if the surviving spouse is under age 65, covered by an eligible HDHP, not enrolled in Medicare.	No.	No.
State Taxes	Generally tax-free. Follows federal non-taxable transfer treatment in most states. (California and New Jersey are exceptions.)	Taxable as ordinary income in the beneficiary's home state (unless they live in a state with no income tax).	Taxable as ordinary income on the deceased’s final state return; balance may also be subject to state probate fees and estate or inheritance taxes.

Sources: Adapted from Q3 Advisors and HSA for America.

A solid estate plan is key

It's not uncommon to hold multiple accounts in retirement, from an IRA to an HSA to a taxable brokerage and cash account. Because some of these accounts come with strict beneficiary rules, it's important to understand what they entail to avoid burdening your loved ones with taxes.

It also pays to sit down with a financial professional and create an estate plan that accounts for these nuances, so your hard-earned wealth serves as a true blessing to your heirs rather than a tax trap.

Maurie Backman is a freelance contributor to Kiplinger. She has over a decade of experience writing about financial topics, including retirement, investing, Social Security, and real estate. She has written for USA Today, U.S. News & World Report, and Bankrate. She studied creative writing and finance at Binghamton University and merged the two disciplines to help empower consumers to make smart financial planning decisions.