Health savings accounts can saddle heirs with unexpected tax bills

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Dying with a large health savings account can leave loved ones facing an unexpected tax bill — a risk many savers don’t realize until it’s too late. With HSAs increasingly used as long-term investment vehicles, understanding how beneficiaries are taxed after an account holder’s death has become urgently important for estate planning.

How HSAs are supposed to work

Health savings accounts give savers a rare triple tax benefit: contributions are made pre-tax, investment growth is tax-deferred, and withdrawals for qualifying medical expenses are tax-free. That combination has led some people to treat HSAs as a long-term nest egg for health costs in retirement.

Only people enrolled in a qualifying high-deductible health plan can put money into an HSA, but once funds are in the account they can be invested and left to compound over many years.

The inheritance catch that surprises heirs

When a spouse inherits an HSA, they can generally step into the account and continue taking tax-free withdrawals for eligible medical care — the account retains its tax-advantaged status. But the rules change sharply for other beneficiaries.

If the heir is not a spouse — for example a child, sibling, friend, or grandchild — the HSA loses its special tax treatment and the account balance is treated as taxable income in the year of the owner’s death. That can push beneficiaries into a much higher federal tax bracket at once.

Financial planners warn this outcome is more onerous than the rules for many retirement accounts. For inherited IRAs, non-spouse heirs often have up to 10 years under post-SECURE Act rules to withdraw funds (subject to other conditions), but HSAs have no comparable multi-year withdrawal window for non-spouse beneficiaries.

What that means in practical terms: if a non-spouse inherits a sizable HSA, the full balance is added to their taxable income for that year and could be taxed at the top federal marginal rate, currently 37% for the highest earners.

Ways to reduce the tax hit

There are several strategies account holders and heirs can consider to limit or avoid the tax burden. Each option has trade-offs and some require advance planning — so act sooner rather than later.

Spend down the account during life: If you already have sufficient resources outside the HSA to pay routine medical bills, using HSA funds for current eligible expenses reduces the balance that would be taxed at death.

Give to charity: Naming a qualified charity as beneficiary can pass HSA assets without creating taxable income for the charity. This can be part of broader philanthropic or estate planning goals.

Divide beneficiary designations: Instead of leaving the account to a single non-spouse, splitting the balance among several beneficiaries may lessen the tax impact on any one person.

Pay the decedent’s final medical bills: A non-spouse beneficiary can use HSA funds to settle the deceased’s unpaid medical expenses within 12 months of death, which reduces the taxable amount. For example, a $50,000 HSA used to cover $10,000 in final medical bills would leave $40,000 subject to income tax.

Keep beneficiaries informed: Letting heirs know where HSA paperwork is and what the intended plan is helps them take timely action and avoid costly surprises.

Practical steps for account holders

Updating beneficiary designations is the most direct way to control post-death outcomes, since the HSA custodian follows those forms. If preserving the account’s tax-advantaged status for a partner is important, naming a spouse is the clearest route.

For those who don’t have a spouse or who want to distribute assets differently, combining beneficiary designations with charitable gifts, spending strategies, or coordination with other estate documents can help achieve goals while limiting tax fallout.

One caution: HSAs are subject to specific tax rules, and small differences in withholding, timing, or beneficiary paperwork can change the outcome. Speak with a tax advisor or estate planning attorney before making major moves.

Why this matters now

HSAs are growing in both use and balances as more people treat them like retirement accounts. That makes the post-death tax treatment of HSAs a timely concern for anyone building a sizable HSA balance.

Proactive planning can prevent heirs from facing an unexpected, large tax bill in the year they inherit funds. A brief review of beneficiary forms and a conversation with a financial professional can save significant money and stress later on.