How to turn HSA funds into charitable donations
"Health savings accounts hold your money - use it any way you want."
The above sentence is one of the biggest misconceptions people have about their HSAs. While it's true that these tax-free healthcare funds are portable, and don't have any "use-it-or-lose-it" provisions, the money is still set aside for qualified health purchases. This means they're subject to penalties for using them towards anything non-healthcare related until age 65.
And this doesn't just apply to those who have big shopping plans for their funds. Even those with more benevolent intentions are subject to penalties if you're not careful. So, how can you bequeath your funds to charity without losing the tax-free benefits? It's not easy, but there IS a way.
A quick refresher…
Like we mentioned above, even though HSA funds are technically your money, you can't just withdraw funds to donate them without being subject to a 20% penalty -- and that's on top of the income tax you'll pay for the trouble. Yes, even if you're trying to be charitable.
Unlike IRAs, which allow for qualified charitable distributions, any HSA funds sent directly to a charity are going to be considered part of your income, and levied accordingly. While it's still good to use your own money to help others, that's a large sum of money to pay on top of a donation.
Benefit others with your benefits
But one thing HSAs allow for is distribution to beneficiaries. You see, when you open an HSA, you're immediately asked to designate a beneficiary who will receive your funds in the event of your death. If the beneficiary is your spouse, they can keep the HSA active and use the funds for tax-free healthcare expenses, just as you did, even if they aren't currently enrolled in an HDHP.
Not bad. But even if your beneficiary isn't a spouse, the HSA ends upon your death. The beneficiary then receives a payout, which is subject to income tax like any other inheritance.
But you can change and add beneficiaries at any time during the life of your account. Keep in mind that many states require a spouse's consent before changing, though, so think this through before changing things up.
So, if you aren't planning to leave HSA funds to a spouse or family member, and you have charitable intentions, what are your options? (Stop me if you know where this is going…)
You can name a qualified charity as a beneficiary. Any entity other than the deceased's spouse or estate can be chosen. Like we mentioned above, in this situation the HSA would be dissolved, and the money given to the charity after being taxed. While this money is taxed as income (even if the charity is healthcare-related) it's a far more benevolent use of the funds than letting it sit in an estate for others to take.
Maybe the process isn't as easy as withdrawing and donating, tax-free. But considering the good that your funds can do for others, designating a charity as a beneficiary is a great way to ensure your savings doesn't disappear once you're gone. Instead, you can use your money to benefit others -- and if that isn't in line with the helping nature of HSAs, we're not sure what is.