Understanding HSA Beneficiary Options

By Kristiana Rodriguez

A recent study by Devenir Research* reported that as of June 30, 2024, there was an estimated $137 billion in assets held in almost 38 million health savings accounts (HSAs). The study also reports that HSA assets and accounts have continued to increase year-over-year.

Financial organizations are responsible for paying out HSA assets to beneficiaries after an HSA owner’s death and properly reporting these distributions to the IRS, so your role as an HSA administrator is important. And because HSA beneficiary options differ from IRA and employer plan beneficiary options, it’s a good idea to familiarize yourself with the options and distribution process.

Tax Treatment after an HSA Owner’s Death

The tax treatment of an HSA after an HSA owner’s death depends on whether a spouse or nonspouse is designated as the HSA death beneficiary.

If the deceased HSA owner’s death beneficiary is a spouse, the HSA is treated as the surviving spouses’ own HSA. If a nonspouse beneficiary is the death beneficiary, the HSA ceases to be an HSA as of the date of death.

Spouse Beneficiary

A spouse beneficiary assumes ownership of the HSA, even if he does not currently have an HSA. He will be able to take tax- and penalty-free distributions to pay for his qualified medical expenses.

If the surviving spouse beneficiary does not have an existing HSA, an HSA should be established. Your financial organization should follow its procedures for opening an HSA in the spouse’s name, including having properly completed and signed HSA opening documents. Although not required, the surviving spouse may wish to complete a transfer form to initiate the transfer—especially if he is moving the assets to another financial organization.

Nonspouse Beneficiary

An HSA ceases to be an HSA if anyone other than a spouse is the beneficiary. This is effective on the date of the HSA owner’s death. The nonspouse death beneficiary must include the HSA’s fair market value (FMV) in her income for the year of the death. According to the IRS’ Instructions for Form 8889, Health Savings Accounts (HSAs), earnings that accrue after the date of death are also reported as income taxable to the nonspouse beneficiary.

A beneficiary may be able to reduce the amount that she must include in her taxable income by any HSA distributions taken within one year of death to pay for qualified medical expenses incurred by the decedent. See the Form 8889 instructions for more information. This does not apply if the beneficiary is the decedent’s estate.

If the beneficiary is the HSA owner’s estate, the HSA’s date of death FMV will be includible as gross income on the HSA owner’s final income tax return, see Form 1099-SA, Distributions From an HAS, Archer, MSA, or Medicare Advantage MSA.

Processing the Distribution

When notified of an HSA owner’s death, you should

obtain a certified copy of the death certificate,
stop any recurring contributions or distributions being made to or from the HSA, and
determine beneficiaries.

Funds will be distributed to a nonspouse beneficiary. If there is no beneficiary designated, follow the beneficiary defaults specified in the HSA plan agreement, typically the HSA owner’s estate, and—if so—take direction from the estate’s personal representative for distribution to an estate account. The distribution to a nonspouse beneficiary will be included in her taxable income, but will not be subject to the 20 percent penalty tax that usually applies to distributions made in the absence of qualified medical expenses. Death is a penalty tax exception.

Reporting the Distribution

Nonspouse Beneficiary

The HSA death distribution will be reported in the nonspouse beneficiary’s name and Social Security number. For an estate or trust beneficiary, you will need to report the distribution using the entity’s tax identification number (TIN).

IRS Form 1099-SA, Distributions from an HSA, Archer MSA, or Medicare Advantage MSA, will be sent to the death beneficiary by January 31 and the IRS by February 28 (or March 31 if filing electronically) of the year following the year in which distributions are made.

Box 1, Gross distribution – Enter the distribution amount.

Box 3, Distribution code -

Code 4, Death distribution other than code 6, is used for distributions to a deceased HSA owner’s estate in any year and for distributions to a nonspouse beneficiary in the year of the HSA owner’s death.

Code 6, Death distribution after year of death to a nonspouse beneficiary, is used to report distributions to a nonspouse beneficiary, other than an estate, that take place in any year after the year of death.

Box 4, FMV on date of death – Enter the HSA’s date of death FMV.

Box 5 – Shows the type of account that is reported.

Spouse Beneficiary

As mentioned earlier, the movement of HSA assets to a spouse beneficiary is done through a direct transfer. The transfer is a nonreportable transaction, even if it is sent to an HSA at a different financial organization. Report any distributions that occur after the HSA owner’s date of death under the spouse’s name and Social Security number.

Reporting the FMV

Spouse Beneficiary

File copy A of Form 5498-SA HSA, Archer MSA, or Medicare Advantage MSA Information, with the IRS by May 31 to report the prior year-end FMV, in Box 5. Provide the new HSA owner (the former spouse beneficiary) with Copy B of IRS Form 5498-SA by May 31 each year to report contributions and to report the year-end FMV.

Summary

Helping your clients keep their beneficiary designations up to date can make the distribution process as easy as possible for everyone involved. If proper procedures are followed, financial organizations should have no difficulty in determining who should receive HSA assets after a death.

For more information on beneficiary designations, see The Importance of Keeping Beneficiary Designations Up to Date.

* “2024 Midyear HSA Market Statistics & Trends Executive Summary,” Devenir Research, Devenir, September 25, 2024, assessed October 30, 2024 https://www.devenir.com/wp-content/uploads/2024-Midyear-Devenir-HSA-Research-Report-Executive-Summary.pdf