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Best way to deal with an inherited, investing HSA using a revocable living trust?

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  • Best way to deal with an inherited, investing HSA using a revocable living trust?

    Hi all,

    My wife and I created a revocable living trust recently just in case something happens to both of us so our infant son is taken care of.

    Our estate attorney mentioned that a trust cannot own an HSA. I understand that if a spouse inherits an HSA, it is not a taxable event, plus they can rollover those funds into their own HSA or create a new one for themselves. If someone else inherits the HSA, it's fully taxable income for them.

    If something happens to both my wife and me, I'd like to know what are my best options.

    I currently pay for medical expenses out-of-pocket using after-tax money. We use my HSA as a stealth IRA. Until the law changes and we are required to be reimbursed the same year for medical expenses, I plan to pay myself back later for my medical expenses from my HSA to it earns some compounding growth.

    If both my wife and I die, can our trustee(s) go and get a reimbursement from our HSA accounts for the amount of medical receipts saved up over the years? This way, our beneficiaries would inherit a much smaller HSA.

    Thanks for your advice all!

  • #2
    https://www.irs.gov/pub/irs-drop/n-04-2.pdf

    From section IV:
    If, by reason of the death of the account beneficiary, the HSA passes to a person other than the account beneficiary’s surviving spouse, the HSA ceases to be an HSA as of the date of the account beneficiary’s death, and the person is required to include in gross income the fair market value of the HSA assets as of the date of death. For such a person (except the decedent’s estate), the includable amount is reduced by any payments from the HSA made for the decedent’s qualified medical expenses, if paid within one year after death.

    Make sure you keep good records and your beneficiaries know the rules and where to find the receipts.

    Comment


    • #3
      Originally posted by GasFIRE View Post
      For such a person (except the decedent’s estate), the includable amount is reduced by any payments from the HSA made for the decedent’s qualified medical expenses, if paid within one year after death.

      Make sure you keep good records and your beneficiaries know the rules and where to find the receipts.
      It is easy to miss, but you are misinterpreting that sentence. It is a little clearer in the Internal Revenue Code.

      26 U.S. Code § 223 - Health savings accounts, (f) Tax treatment of distributions, (8) Treatment after death of account beneficiary, (B) Other cases
      (i) In general, (I)
      such account shall cease to be a health savings account as of the date of death,
      (ii) Special rules. (I) Reduction of inclusion for predeath expenses
      The amount includible in gross income under clause (i) by any person (other than the estate) shall be reduced by the amount of qualified medical expenses which were incurred by the decedent before the date of the decedent’s death and paid by such person within 1 year after such date.

      A non-spouse beneficiary can only deduct the decedent's unpaid qualified medical expenses paid by them within one year of the decedent's death. The account is no longer an HSA and they can not reimburse unreimbursed qualified medical expenses.

      I recommend evey HSA account owner with non-spouse beneficiaries should have a plan to reimburse all unreimbursed qualified medical expenses before they die. For example, my plan was to use a 10-year RMD-like distribution plan from 65 - 75. 1/10 the balance the first year 1/9 the balance the second year and so on. At Age 75 pay all expenses directly from the HSA account or reimburse ASAP. Others don't want to burden the remaining spouse and have directed them to reimburse 100% of the unreimbursed qualified medical expenses, as soon as is reasonably possible.

      This doesn't address the lump sum taxable distribution of any remaining balance by non-spouse beneficiaries. Consider naming the individual with the lowest marginal tax rate (or who was going to blow thru and inherited account anyway) as HSA beneficiary. Another option if you are leaving charitable bequests anyway. To the degree possible make the charities your non-spouse beneficiary



      Comment


      • #4
        The only way a trustee can get funds from an HSA is if the trustee/trust owns it. If you try to name a minor as a designated beneficiary, you'll probably end up with an expensive guardianship, with the guardian holding the funds. Be sure to work with the institution holding your HSA to find a scenario you're comfortable with.

        Comment


        • #5
          Originally posted by spiritrider View Post
          The amount includible in gross income under clause (i) by any person (other than the estate) shall be reduced by the amount of qualified medical expenses which were incurred by the decedent before the date of the decedent’s death and paid by such person within 1 year after such date.

          A non-spouse beneficiary can only deduct the decedent's unpaid qualified medical expenses paid by them within one year of the decedent's death. The account is no longer an HSA and they can not reimburse unreimbursed qualified medical expenses.
          Hmmm, I guess I need some clarification on the rules. I have years of receipts of health care expenses that have been paid, but not yet reimbursed from both my and my wife's HSAs. I am actually planning something similar to you, hopefully disbursing most of the HSA funds before starting IRA RMDs. Are you saying that if both of us were to pass before spending down the HSAs, non-spouse beneficiaries can't present unused receipts to reduce the HSA size? My interpretation (though I have not obtained any professional advice on this matter) was that old receipts are paid expenses, just not reimbursed yet from the HSA. If this is not true, I may want to start HSA disbursements earlier than initially planned.

          Comment


          • #6
            That is exactly what I am saying. The tax code explicitly uses the language; "paid by the person."

            The "person" they are referring to is referenced in the previous subparagraph B, (i)
            any "person" acquires the account beneficiary’s interest in a health savings account in a case to which subparagraph (A) does not apply

            Subparagraph B is for non-spouse beneficiaries and the subparagraph A that does not apply is for spouse beneficiaries.

            Comment


            • #7
              I was so excited to post on the WCI forum that I did not bother to check for similar threads first...

              https://forum.whitecoatinvestor.com/...767#post222767

              Still appreciate others chiming in with suggestions!

              Seems like the beneficiary of an HSA would have a year after my wife and I die to get reimbursed for prior medical expenses my family paid out of pocket over the years. Not sure if trustee can do this on our minor son's behalf, then put whatever money is left after taxes into the trust entity.

              Originally posted by Gavin West View Post
              The only way a trustee can get funds from an HSA is if the trustee/trust owns it. If you try to name a minor as a designated beneficiary, you'll probably end up with an expensive guardianship, with the guardian holding the funds. Be sure to work with the institution holding your HSA to find a scenario you're comfortable with.
              Ok, I will email Fidelity where my HSA is held and ask them what's possible. Our estate attorney didn't have a ready suggestion for how to deal with HSAs (e.g. retitling or how to fill in a beneficiary form for it). I guess once I find an answer, I'll report it back to him. Bet he'll get more and more clients like me investing their HSAs as the years go by..

              Our son is still a minor, so I guess he can't inherit the HSA, but the trust can't inherit it either, our estate attorney told me. Not sure if that means we have to specify that a trustee has to inherit it (?).

              Thank you for your suggestion!

              Comment


              • #8
                Originally posted by spiritrider View Post
                That is exactly what I am saying. The tax code explicitly uses the language; "paid by the person."

                The "person" they are referring to is referenced in the previous subparagraph B, (i)
                any "person" acquires the account beneficiary’s interest in a health savings account in a case to which subparagraph (A) does not apply


                Subparagraph B is for non-spouse beneficiaries and the subparagraph A that does not apply is for spouse beneficiaries.
                This h/b my understanding, but I w/h never found and interpreted so quickly, succinctly and correctly as you. Another one for my spiritrider reference file for both financial planning and CPA side. Thank you, SR!
                Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

                Comment


                • #9
                  Originally posted by spiritrider View Post
                  It is easy to miss, but you are misinterpreting that sentence. It is a little clearer in the Internal Revenue Code.

                  26 U.S. Code § 223 - Health savings accounts, (f) Tax treatment of distributions, (8) Treatment after death of account beneficiary, (B) Other cases
                  (i) In general, (I)
                  such account shall cease to be a health savings account as of the date of death,
                  (ii) Special rules. (I) Reduction of inclusion for predeath expenses
                  The amount includible in gross income under clause (i) by any person (other than the estate) shall be reduced by the amount of qualified medical expenses which were incurred by the decedent before the date of the decedent’s death and paid by such person within 1 year after such date.

                  A non-spouse beneficiary can only deduct the decedent's unpaid qualified medical expenses paid by them within one year of the decedent's death. The account is no longer an HSA and they can not reimburse unreimbursed qualified medical expenses.

                  I recommend evey HSA account owner with non-spouse beneficiaries should have a plan to reimburse all unreimbursed qualified medical expenses before they die. For example, my plan was to use a 10-year RMD-like distribution plan from 65 - 75. 1/10 the balance the first year 1/9 the balance the second year and so on. At Age 75 pay all expenses directly from the HSA account or reimburse ASAP. Others don't want to burden the remaining spouse and have directed them to reimburse 100% of the unreimbursed qualified medical expenses, as soon as is reasonably possible.

                  This doesn't address the lump sum taxable distribution of any remaining balance by non-spouse beneficiaries. Consider naming the individual with the lowest marginal tax rate (or who was going to blow thru and inherited account anyway) as HSA beneficiary. Another option if you are leaving charitable bequests anyway. To the degree possible make the charities your non-spouse beneficiary


                  Thanks for digging into this, Spiritrider!

                  Pretty disappointed that my wife and I can't hoard our receipts forever, knowing that if we both were to die unexpectedly that our beneficiaries would not be able to cash in all those medical receipts paid out of pocket over the years using the HSA. Guess we'll have to whittle down that HSA balance if it gets really big before we retire and definitely start draining the account once we're both age 65.

                  She and I are still young and healthy, plus our HSA invested balance is only ~$30,000. $30,000 in taxable income for an individual isn't terrible, but I have no idea how the IRS would treat our minor son as a beneficiary for this. The rest of our assets easily get swept up into the trust for our trustee(s) to manage. Too bad the IRS makes inherited HSAs a pain to deal with in the first place.

                  Comment


                  • #10
                    Originally posted by index2max View Post
                    Seems like the beneficiary of an HSA would have a year after my wife and I die to get reimbursed for prior medical expenses my family paid out of pocket over the years. Not sure if trustee can do this on our minor son's behalf, then put whatever money is left after taxes into the trust entity.
                    This is incorrect as I pointed out and explicitly referenced the tax code.
                    • As I already quoted from the tax code; "such account shall cease to be a health savings account as of the date of death"
                    • A beneficiary can not take distributions to reimburse previous unreimbursed qualified medical expenses. They can only take a full lump sum taxable distribution.
                    • A beneficiary can only deduct unpaid expenses directly paid by them within one year of death.
                    An HSA can not be assigned to a trust, but a trust can be made a beneficiary of an HSA account. However, as pointed out above, a trust can not reimburse unreimbursed qualified medical expenses, The trust acting on behalf of the beneficiary must take a full lump sum taxable distribution and can only deduct the decedent's unpaid qualified medical expenses paid within one year of the decedent's death. A properly constructed trust should generally only retain that amount of the taxable distribution subject to trust marginal tax rates <= the beneficiary's marginal tax rates.

                    Comment

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