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Handling HSAs After Death or Divorce

Many health savings accounts have grown quite large and merit careful consideration in divorce or inheritance planning.

Helen Modly and Tommie Monez, 10/13/2016

Remember when IRAs were a new idea? Then they became mainstream, and then we began to commonly see them as assets to be dealt with in death and divorce. And so it is with health savings accounts (HSAs). They may still seem like a new idea, but HSAs have now been with us for 13 years, and some of the balances have become quite large.

Health Savings Account Basics
HSAs are tax-exempt custodial accounts. Tax-deductible contributions can be made up to specified annual amounts, there are no income restrictions for contributing, and they must be used in conjunction with a qualified high-deductible health insurance plan. You can continue to withdraw from the HSA plan to cover qualified medical expenses even after you are no longer eligible to contribute, usually due to a change in health insurance plan or hitting age 65. Medicare recipients can no longer contribute because they are covered by Medicare Part A and cannot qualify for a high-deductible plan. HSA dollars can be used to pay for Part B premiums but not Medicare supplement policies.

Funds that are withdrawn and not used for qualified medical expenses are considered to be taxable distributions and are subject to a 20% penalty unless the taxpayer is 65 or older.

The current HSA maximum contribution for a family is $6,750, and $3,350 for a single person ($4,350 if over age 55). Contribution limits are indexed for inflation, and the accounts can be invested as aggressively or conservatively as desired. Many HSA contributors prefer to allow the accounts to grow for future use rather than using them for medical expenses, so it's not hard to believe that a considerable number of accounts are now worth over $100,000.

HSAs and Divorce
Actually, at first it was hard to believe: A client in the process of divorce came in with a list of family assets, and one of them was a health savings account in the amount of $85,000. Neither the advisor nor the attorney had ever encountered an HSA as part of property division, and both were quite surprised at the amount. The next question was, "How should it be divided?"

HSAs are actually handled like IRAs in a divorce. Interest in an HSA can be transferred between spouses as part of a divorce or separation agreement. It is not considered a taxable transfer, and the interest that is transferred keeps its identity as an HSA for the receiving spouse. The transferred HSA can be moved to a new trustee or administrator if desired and invested as the recipient sees fit. Expenses incurred before the new HSA is established are not qualified for reimbursement. In order to avoid this gap, trustee to trustee transfer is recommended, rather than a direct rollover. 

IRS guidelines allow for either parent to use HSA funds for children's eligible expenses, no matter which parent is taking the children as dependents for tax purposes and regardless of which parent has physical custody of the children.  

Quite often, ex-spouses will be required to keep their former spouses on their medical plan for a period after divorce. However, they may not use their own HSA to cover the former spouse's eligible medical expenses. Funds withdrawn for such a purpose are taxed as ordinary income and are subject to the 20% penalty unless the taxpayer is 65 or older.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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