As high deductible health insurance plans become more prevalent, so do health savings accounts (HSAs). While most participants are aware of the tax implications of an HSA during life (contributions are deductible from gross income, up to a maximum contribution per year), many participants have not thought through the tax implications of an HSA at death or divorce. As HSAs become more prevalent, and participants keep the account for longer periods of time, it is likely some HSAs will hold substantial value. In those cases, planning for distribution at death or divorce becomes essential.
Just like an IRA or a bank account, an HSA is an asset that can be divided or distributed in a divorce. Typically, the holder of the account (the bank or insurance company that your account is with) will have its own procedures for dividing or transferring the account to an ex-spouse pursuant to a divorce decree. Generally, so long as the division or transfer is pursuant to a divorce decree and the individual never actually takes possession of the funds, the transfer is not treated as a distribution and therefore is not taxed.
Each account holder will likewise have its own forms and procedures for naming a beneficiary of an HSA. Who you name as beneficiary of your HSA will have tax consequences. If your spouse is the named beneficiary, the HSA becomes your spouse's HSA upon your death (and following the completion of any required documentation). The account is not included in income of the surviving spouse, and the account continues to operate as an HSA, with tax free distributions for qualified medical expenses. (Keep in mind, HSA's only have one "owner;" it is not like a standard bank account that can be jointly owned.)
If you name someone other than a surviving spouse as beneficiary, the HSA is no longer considered an HSA and will essentially be cashed out. The beneficiary must include the value of the HSA in his or her income as of the date of death. If you fail to name a beneficiary, the account will cease to be an HSA at death and will be distributed (and taxed) to your estate. Thus, if you are married, it is very advantageous to name the spouse as beneficiary, and to get the favorable tax treatment.
As HSAs become more common, it is important to consider the HSA in various capacities, including in premarital agreements, death, and divorce.