Your HSA might seem like the perfect inheritance for your kids, but there’s a nasty tax surprise waiting for them.
Here’s what you probably don’t know: When you leave your HSA to anyone except your spouse, it stops being an HSA the moment you die. That entire balance becomes taxable income to your non-spouse beneficiary, and the account turns into a taxable investment account.
Say you have $50,000 in your HSA, $50,000 in a Roth IRA, and your child makes $50,000 a year in California.
What happens with the $50,000 in the Roth IRA? They inherit all $50,000 tax-free. Nice and simple.
But that $50,000 HSA? It becomes fully taxable income, pushing your child’s income from $50,000 to $100,000 in the year you die. Now they’re paying federal taxes at a higher tax bracket, plus California’s 9.3% state tax on that generous gift.
The tax bill? $15,500. Your $50,000 HSA just became a $34,500 inheritance after taxes.
So what’s the smart move? Spend your HSA before you die. Use it for regular medical expenses or long-term care after the age of 65. Every dollar you withdraw tax-free is better than leaving it as an inheritance for your kids.
And since you’ve spent your HSA money while you’re alive, that might allow your Roth IRA to grow a little bit more, which will be a much better, tax-free inheritance for your kids.