Graber & Johnson Law Group LLC Blog

What are Digital Assets in a Will?

“Most family members may not have a clue what we have floating out in cyberspace. Accessing or deleting accounts can be tricky for family members, if they don’t have your login credentials.”

Most of us overlook the amount of information and assets we have online, from social media to networking websites, frequent flier miles, online bank accounts, subscriptions, photos, websites, etc. The list of most people’s digital assets has grown considerably in recent years, and yet most have no plan for what should happen to those assets when their owner dies.

This is a growing problem, says msn money, in an article making the case clear: “From Facebook to iTunes to Amazon, You Need A Digital Will!” Every website has its own legal requirements for dealing with the original owner’s death, almost aways hidden deep within the Terms of Service Agreement we all click on without reading. Some have created processes for executors, while others have not. What can you do to make it easier for your executor?

Make a list of everything you access online. Be prepared to be surprised at just how much of your life occurs online. Compile a list of all online accounts, usernames and passwords. You probably have to do this bit by bit, as a marathon session might take a long time. Use either a password manager with top-notch security or a password-protected spreadsheet you update around once every three months.

This is especially important for accounts with monetary value. But sentimental value counts too. A side note: all those playlists you’ve created on iTunes? They are non-transferrable and when you die, they are deleted.

What do you want to have happen to each account? You’ll need to decide what you want to happen to each account and, depending on the account, state it clearly in what’s known as a directive. You may want to preserve some, or you may want to shut down others. Some free email accounts are automatically shut down, if they are not used for a certain period of time. Others should be shut down immediately to prevent fraud. Scammers prefer accounts where the owners have died, since they are often an easy entry to the person’s online identity.

Facebook is one of the platforms allowing you to designate a Legacy contact, so the person can memorialize the account, allowing only friends to see the page and removing some information. If you want to have the page deleted on death, Facebook provides directions.

Each platform has its own rules. Most rely on provisions regarding privacy protection: only the original owner is authorized to access the account. There are now federal and state laws prohibiting accessing private online data, which have created significant obstacles for loved ones to access digital assets. Don’t expect anyone to resolve your digital accounts after you pass, unless you have a digital will. Even with one, there might be issues.

Your estate planning attorney will help you add the correct language to your estate documents as to what you want to happen to each account. It’s important to ensure that your estate plan gives your executor or other fiduciary authorization to access your digital assets and what you want to happen to them. Remember—don’t put account names, usernames, or passwords in a will, as it becomes a public document during the probate process.

Without an inventory of digital assets, it may be simply impossible to ascertain where digital assets are located and how to access them. Looking at credit card statements for autopayments may be a place to start, or at least to stop the autopayments.

This is a relatively new asset class, with laws varying from state to state. Speak with your estate planning attorney to ensure your digital assets are protected, as well as traditional assets when creating or reviewing your estate plan.

Reference: msn money (Dec. 19, 2021) “From Facebook to iTunes to Amazon, You Need A Digital Will!”

Can You Remove Someone from a Life Estate?

“Life estates can provide effective means to create joint ownership of property, avoid probate and transfer property after death without incurring gift taxes.”

Parents often use life estates to leave the family home to children, while remaining in the house for the rest of their lives. However, sometimes things don’t work out as intended. If and how changes may be made to a life estate is the focus of a recent article “How to Remove Someone from a Life Estate” from Yahoo! Finance. For the life estate to be flexible, certain provisions must be in the document when it is first created. An experienced estate planning attorney is needed to do this right.

A life estate allows two or more people to jointly own real estate property. One person, referred to as the “life tenant” has ownership of the property for as long as they live. The other person, called the “remainderman,” takes possession only after the life tenant’s death. Multiple people can be named as life tenant and remainderman. However, the more people involved, the more complicated this arrangement becomes.

The remainderman has an unusual position. They don’t have full possession of the property until the life tenant dies, yet they have an interest in the property. The life tenant is not allowed to do certain things, like take out a mortgage or sell the property, without the consent of the remainderman.

The remainderman must agree to any changes in any person or persons named as other remaindermen. If there’s more than one, which happens when there’s more than one adult child, for instance, all of the remaindermen must agree, before any names on the life estate can be removed or changed.

If one of the remainderman becomes heavily indebted, has a contentious divorce, or is sued for a considerable sum, their share of the property could be lost to creditors, ex-spouses, or adversaries. In that case, removing the problematic remainderman could protect the value of the home.

Most life estates are irrevocable, and the laws concerning life estates vary by state.

One way to work around the need for remainderman approval is to use a Testamentary Power of Appointment, a clause in a will permitting the life tenant to change the person to whom the property will be left upon death. Invoking the Power of Appointment doesn’t make the life estate invalid, so the tenant is still constrained from selling the property or taking any other actions without permission from the remaindermen.

The testamentary power of appointment does give the life tenant some negotiating muscle but must be built into the documents from the start.

Another trust used in this situation is the Nominee Realty Trust. This is a revocable trust holding legal title to real estate. A property owner files a new deed transferring ownership to the nominee realty trust. The trust specifies who receives the property after the owner’s death. The grantor of the nominee trust can direct the actions of the trustee, so the life tenant has the legal ability to tell the trustee to change the names of the remaindermen. This flexibility may be desirable when the children are problematic. This has to be set up when the life estate is first established.

There are occasions when the remainderman wants to terminate the interest of the life tenant. This is actually easier than removing or changing the remainderman but requires the life tenant to do something particularly egregious or illegal. The life tenant has certain rights: to rent out the property, to change or improve the property—as long as the property is being improved. The life tenant is responsible for paying taxes, maintaining the property and avoiding any liens being placed on the property.

If the life tenant does not fulfill their responsibilities or allows the property to lose value, it may be possible for the remainderman to have the life tenant’s interest terminated. However, that depends upon the provisions in the life estate. This option should be discussed and planned for when the life estate is created.

Reference: Yahoo! Finance (Dec. 16, 2021) “How to Remove Someone from a Life Estate”

Should Young Adults have a Will?

“Millennials are finally embracing one of the cornerstones of adulthood, by writing their wills.”

Young adults are starting to get their affairs in order, contacting estate planning attorneys because they are concerned about dying unexpectedly. A study by Caring.com, a senior referral service, said that almost a third of young adults, ages 18—34, had a will in 2021, compared to 18% in 2019. The leap, according to a recent article in The Wall Street Journal titled “Millennials, Feeling Their Mortality During Covid-19, Start Writing Their Wills” can be directly attributed to the Covid-19 pandemic.

The concern over continued uncertainty regarding whether the young adults themselves or their family members will become sick and die is all too real. Millennials also haven’t experienced another event: sharply rising inflation. The general sense of unease and instability is leading young adults to make sure they have wills and healthcare proxies in place to give some sense of control in the face of an unstable world. Those with young families are especially concerned, as new variants of Covid emerge.

Before the pandemic, young adults, even with those with children, didn’t feel the need to have an estate plan created. That’s changed.

Just under half of all Americans have a will, and people 65 and up have traditionally been more likely to have one, according to a May 2021 study by Gallup. This number has been relatively stable since about 1990.

If you die without a will, the state law determines how to distribute assets, under court supervision. The process is slower and far more costly for survivors. In many situations, not having a will can be catastrophic. If beneficiaries with special needs inherit funds outright, and not in a Supplemental Needs Trust (or a Special Needs Trust), they could lose government benefits necessary for their day-to-day lives.

Wills are also used to name a guardian to care for minor children. If both parents die and there is no will, a court will decide who should raise a child. The court may not necessarily name a family member, and the person may not be who the parents or grandparents might have wished.

Similarly, news about young celebrities dying unexpectedly also pushes the “go” button for millennials to get their wills completed. When Los Angeles Angels pitcher Tyler Skaggs died of a fentanyl overdose in 2019, calls to estate planning attorneys from millennial males increased in many law offices. At the same time, millennials who are aware of the importance of a will for themselves and their families are pressing their parents to get their wills prepared or updated.

In every case, having a will is far less costly than not having a will. The cost of preparing a will depends on many factors: the size of the estate, the complexity of the family situation, the nature of assets and where the will is being prepared. Other documents are necessary. For example, every adult should have a power of attorney, health care proxy, living will and possibly a trust.

The last gift you leave your heirs is a plan and organized documents, so they can grieve properly after you pass, rather than having to embark on a scavenger hunt through decades of paperwork and old files.

Reference: The Wall Street Journal (Dec. 6, 2021) “Millennials, Feeling Their Mortality During Covid-19, Start Writing Their Wills”

Is It Better to Inherit Stock or Cash?

“If you’re planning to leave your heirs any sort of inheritance, you’re already giving them a valuable financial leg up.”

To make an inheritance even more advantageous for heirs, it’s a good idea to streamline accounts and simplify what you own before you die, eliminating some complications during a very emotional time. The next three decades will see a massive transfer of wealth from one generation to the next, says a recent article “6 of the Best Assets to Inherit” from Kiplinger. If you might be among those leaving inheritances to loved ones, there are steps you can take to prevent emotional and even family-destroying fights resulting from problematic assets.

Cash is king of inheritance assets. It’s simplest to deal with and the value is crystal clear. If you have accounts in multiple financial institutions, consolidate cash into one account. Each bank may have different rules for distributing assets, so reducing the number of banks involved will make it easier. Just remember to stay within FDIC limits, which insures only $250,000 per bank per ownership category. Tell your children if they are going to receive a significant cash inheritance and discuss what they may want to do with it.

Cash substitutes. Proceeds from a life insurance policy are usually very cut and dried. When you pass away, the life insurance company pays beneficiaries the death benefit in cash, according to the beneficiaries named on the policy. Be sure to tell your heirs where the original policy is located. They’ll need to provide the insurance company with a death certificate and there may be a form or two involved. The proceeds are income tax free, although the death benefit itself is added to the value of your estate and might be charged estate taxes.

Bank products, like CDs and Money Market Accounts. You can set up these accounts to be Payable on Death (POD), so the person named can access the assets quickly after your death. Don’t put one person’s name on the account and hope they share with their siblings. That’s a recipe for family disaster. If your will has one set of instructions and the bank product names another owner, the bank will pay according to the titling of the account. The same goes for life insurance proceeds—the beneficiary designation supersedes instructions in a will.

Brokerage Accounts. Stocks, bonds, mutual funds and other assets held in a taxable brokerage account are easy to divide and value. They are also easy to sell and convert to cash. What’s more, they could give heirs a significant tax benefit. If you bought shares of Apple or IBM years ago and sold the stocks while you were living, you’d owe capital gains taxes. However, if the investments are inherited, the heir receives a step-up-in-basis, which means the investment basis goes to the market value on the day you die. It’s entirely possible for heirs to sell appreciated assets with no or little taxes due.

Assets that decrease in value fast: this is not for everyone. Let’s say you know your heir is going to take their inheritance and buy an over-the-top luxury item, like a new sports car or a yacht. You know the asset will lose value the minute it’s driven out of the showroom or launched for the first time. Rather than leave them cash to make a purchase, buy the car or boat yourself and leave it to them as an inherited asset. They lose value immediately, while reducing your taxable estate. You’ve always wanted a Lamborghini anyway.

Roth IRA—Best of All IRA Worlds. The Roth IRA is funded with after-tax dollars, and in exchange, retirement withdrawals and investment gains are income tax-free. If you leave a 401(k) or traditional IRA, heirs will owe taxes on withdrawals and unless they meet certain requirements, they have to empty the account within ten years.

Trust Fund Assets. This may be the best way to protect an inheritance from heirs. If you leave property outright to heirs, it’s subject to creditors and predators. Funds in a trust can be carefully protected, according to the terms of the trust, which you determine. Your estate planning attorney can create the trust to achieve whatever you want. Inheritances in trusts are less likely to evaporate quickly and you get the final say in how assets are distributed.

Reference: Kiplinger (Dec. 9, 2021) “6 of the Best Assets to Inherit”

James Brown Estate Battle Resolved … Almost, but Not Quite

“For more than a decade, Brown’s heirs and estate administrators, including Mr. Bauknight and Adele Pope, a former executor, have battled in court over the value of his estate.”

A company specializing in buying and marketing estates and song catalogs has bought the assets of James Brown’s estate, including music rights, real estate and control over Brown’s name and likeness. It is hoped that the sale, worth an estimated $90 million, will finally achieve Brown’s wishes to finance scholarships for needy children, according to a recent article from The New York Times titled “After 15 Years of Infighting, James Brown’s Estate is Sold.”

The money will be used to endow the Brown scholarship trust in perpetuity, said the accountant who has served as the Brown estate’s executor since 2009. The deal includes a provision for the buyer, Primary Wave, to also contribute a percentage of future earnings to the scholarships, intended for children in South Carolina, where Brown was born, and Georgia, where he grew up.

This is a step forward in one of the longest and most contentious estate conflicts in the high-profile world of celebrity estates. Multiple lawsuits in state and federal courts have cost millions in legal fees and left behind what one official described as “As big a tangle as you’ve ever seen.”

Part of the mess centered around Ms. Tommie Rae Hynie, a singer who married James Brown in 2001. It was later learned she was already married to another man. With her spousal status unclear, Ms. Hynie and five of Brown’s children battled over the estate. Their goal was to set aside his will and negotiate a settlement of their own to receive big chunks of the estate.

They found a willing listener in a state attorney general and a state judge who approved their agreement in 2009. However, four years later, the South Carolina Supreme Court struck down their settlement, calling it “a dismemberment of Brown’s carefully crafted estate plan.” It also ruled unanimously that Ms. Hynie was not Mr. Brown’s legal spouse.

Brown’s heirs and several executors have also fought over the estate’s value. One estimated it as $5 million, while another put it at $84 million. The discrepancy was claimed to be a result of savvy management of the estate after Brown’s death.

Negotiations for the sale were handled by John Branca, who was Michael Jackson’s longtime attorney and one of the executors of Jackson’s estate.

However, it’s not over yet. For one thing, the longstanding battle between two executors, Mr. Bauknight and Ms. Pope, removed as executor in 2009, isn’t over. She is suing the estate; he and others have filed suit against her. These cases are under appeal and until they are settled, or a court decision is made, no distributions can be made and no scholarships can be paid.

Reference: The New York Times (Dec. 13, 2021) “After 15 Years of Infighting, James Brown’s Estate is Sold.”

Why Naming Beneficiaries Is Important to Your Estate Plan

“If you’ve ever spent time working through your estate plan, you know how important it is to select and update your beneficiaries.”

For the loved ones of people who neglect to update the beneficiaries on their estate plan and assets with the option of naming beneficiaries, the cost in time, money and emotional stress is quite high, says the recent article “Five Mistakes To Avoid When Naming Beneficiaries” from The Chattanoogan.

The biggest mistake is failing to name a beneficiary on all of your accounts, including retirement, investment and bank accounts as well as insurance policies. What happens if you fail to name a beneficiary? Assets in the accounts and proceeds from life insurance policies will automatically become part of your estate.

Any planning you’ve done with your estate planning attorney to avoid probate will be undercut by having all of these assets go through probate. Beneficiaries may not see their inheritance for months, versus receiving access to the assets much sooner. It’s even worse for retirement accounts like IRAs. Any ability your heir might have had to withdraw assets over time will be lost.

Next is forgetting to name a contingency beneficiary. Most people name their spouse, an adult child, or a sibling as their primary beneficiary. However, if the primary beneficiary should predecease you and there is no contingent beneficiary, it is as if you didn’t have a beneficiary at all.

Having a contingent beneficiary has another benefit: the primary beneficiary has the option to execute a qualified disclaimer, so some assets may be passed along to the next-in-line heir. Let’s say your spouse doesn’t need the money or doesn’t want to take it because of tax implications. Someone else in the family can more easily receive the assets.

Naming beneficiaries without taking care to use their proper legal name or identify the person with specificity has led to more surprises than you can imagine. If there are three generations of Geoffrey Paddingtons in the family and the only name on the document is Geoffrey Paddington, who will receive the inheritance? Use the person’s full name, their relationship to you (“child,” “cousin,” etc.) and if the document requires a Social Security number for identification, use it.

When was the last time you reviewed beneficiary documents? The only time many people look at these documents is when they open the account, start a new job, or buy an insurance policy. Every few years, around the same time you review your estate plan, you should gather all of your financial and insurance documents and make sure the same people named two decades ago are still the ones you want to receive your assets on death.

Finally, talk with loved ones about your legacy and your wishes. Let them know that an estate plan exists and you’ve given time and thought to what you want to happen when you die. There’s no need to give exact amounts. However, a bird’s eye view of your plan will help establish expectations.

If naming beneficiaries is challenging because of a complex situation, your estate planning attorney will be able to help as a sounding board or with estate planning strategies to accomplish your goals.

Reference: The Chattanoogan (Dec. 6, 2021) “Five Mistakes To Avoid When Naming Beneficiaries”

How Do You Split an Estate in a Blended Family?

“Good estate planning must consider more than what you want to happen to your property and for your beneficiaries. It also must consider what you intentionally want to avoid happening.”

Estate planning attorneys know just how often blended families with the best of intentions find themselves embroiled in disputes, when the couple fails to address what will happen after the first spouse dies. According to the article “In blended families, estate planning can have unintended issues” from The News-Enterprise, this is more likely to occur when spouses marry after their separate children are already adults, don’t live in the parent’s home and have their own lives and families.

In this case, the spouse is seen as the parent’s spouse, rather than the child’s parent. There may be love and respect. However, it’s a different relationship from long-term blended families where the stepparent was actively engaged with all of the children’s upbringing and parents consider all of the children as their own.

For the long-term blended family, the planning must be intentional. However, there may be less concern about the surviving spouse changing beneficiaries and depriving the other spouse’s children of their inheritance. The estate planning attorney must still address this as a possibility.

When relationships between spouses and stepchildren are not as close, or are rocky, estate planning must proceed as if the relationship between stepparents and stepsiblings will evaporate on the death of the natural parent. If one spouse’s intention is to leave all of their wealth to the surviving spouse, the plan must anticipate trouble, even litigation.

In some families, there is no intent to deprive anyone of an inheritance. However, failing to plan appropriately—having a will, setting up trusts, etc.—is not done and the estate plan disinherits children.

It’s important for the will, trusts and any other estate planning documents to define the term “children” and in some cases, use the specific names of the children. This is especially important when there are other family members with the same or similar names.

As long as the parents are well and healthy, estate plans can be amended. If one of the parents becomes incapacitated, changes cannot be legally made to their wills. If one spouse dies and the survivor remarries and names a new spouse as their beneficiary, it’s possible for all of the children to lose their inheritances.

Most people don’t intend to disinherit their own children or their stepchildren. However, this occurs often when the spouses neglect to revise their estate plan when they marry again, or if there is no estate plan at all. An estate planning attorney has seen many different versions of this and can create a plan to achieve your wishes and protect your children.

A final note: be realistic about what may occur when you pass. While your spouse may fully intend to maintain relationships with your children, lives and relationships change. With an intentional estate plan, parents can take comfort in knowing their property will be passed to the next generation—or two—as they wish.

Reference: The News-Enterprise (Dec. 7, 2021) “In blended families, estate planning can have unintended issues”

How Much Is the Required Minimum Distribution from Retirement Accounts?

“Americans are living longer than they were a generation ago, and the government knows it. Starting in 2022, that will be reflected in the amount of money you have to draw from retirement accounts at different ages.”

The IRS has updated the formulas for Required Minimum Distributions, or RMDs, the amounts required to be taken annually from 401(k)s, 403(b)s, or traditional Individual Retirement Accounts (IRAs) in 2022. According to a recent article from AARP titled “How an IRS Rule Update Impacts Required Minimum Distributions,” the new RMDs will be smaller now than in previous years. RMDs have always been a complicated topic, and now they might just be a little more so.

Getting the calculations right has always been a bit of a muddle. For one thing, in 2020 RMDs were suspended entirely. Before the pandemic, the 2019 SECURE Act changed the age when you had to take withdrawals from 70½ to 72. This was except for people who were already taking RMDs in 2019. Are you confused?

Now, if your 72^nd birthday occurred before July 1, 2021, you need to take an RMD before December 31. However, if your 72^nd birthday takes place in the second half of 2021, you have until April 1, 2022 to take your first withdrawal—only you’ll need to use the 2021 tables from the IRS to calculate it.

A reminder: Roth IRAs do not require any RMDs, but 401(k) Roths do.

Starting in 2022, many people will be able to take about six or seven percent less in their RMD under the life expectancy tables from the IRS. A 75-year-old single woman with an IRA worth $100,000 at the end of 2021 will need to withdraw at least $4,065 in 2022, about $300 less than under prior guidelines.

However, you need to consider whether or not taking less from your IRA or 401(k) or 403(b) is a good idea in the long run. If you need to take more to live on, then you need to withdraw what you need, regardless of the IRS rules. There’s no penalty for taking more, except the taxes you’ll pay.

If you retire before age 70, before any RMDs are required, you might want to withdraw more from your tax-deferred retirement accounts in order to delay taking Social Security benefits. The longer you delay taking Social Security benefits, the larger your monthly payment will be. This is a good move for many Americans, especially those who are counting on Social Security for income in their 80s and 90s.

There isn’t a single person in America (well, maybe there is one) who isn’t frustrated by having to pay taxes on earned income required to be withdrawn from retirement accounts. However, there are ways to blunt the impact of income taxes on IRAs. Those who are older than 70½ can donate to registered 501(c)(3) charities, by making a Qualified Charitable Distribution (QCD), which is counted toward any RMD as the amount of the donation is exempted from income taxes. However, this only works if you take the standard deduction and don’t itemize charitable gifts.

Unless the rules change, converting tax-deferred IRA money into a Roth IRA is a strategy to shift not whether you pay taxes, but when. Converting traditional IRA assets during a low-income year—or a portion of traditional IRA assets—allows the money in the Roth account to continue to grow tax free and no taxes are due on any withdrawals. Unless the laws change—again.

Reference: AARP (Dec. 8, 2021) “How an IRS Rule Update Impacts Required Minimum Distributions”

Does a TOD Supersede a Trust?

“Both help you pass down assets, while avoiding the time and expense of probate. However, one has much more flexibility than the other.”

Many people incorporate a TOD, or “Transfer on Death” into their financial plan, thinking it will be easier for their loved ones than creating a trust. The article “TOD Accounts Versus Revocable Trusts—Which Is Better?” from Kiplinger explains how it really works.

The TOD account allows the account owner to name a beneficiary on an account who receives funds when the account owner dies. The TOD is often used for stocks, brokerage accounts, bonds and other non-retirement accounts. A POD, or “Payable on Death,” account is usually used for bank assets—cash.

The chief goal of a TOD or POD is to avoid probate. The beneficiaries receive assets directly, bypassing probate, keeping the assets out of the probate estate and transferring them faster than through probate. The beneficiary contacts the financial institution with an original death certificate and proof of identity.  The assets are then distributed to the beneficiary. Banks and financial institutions can be a bit exacting about determining identity, but most people have the needed documents.

There are pitfalls. For one thing, the executor of the estate may be empowered by law to seek contributions from POD and TOD beneficiaries to pay for the expenses of administering an estate, estate and final income taxes and any debts or liabilities of the estate. If the beneficiaries do not contribute voluntarily, the executor (or estate administrator) may file a lawsuit against them, holding them personally responsible, to get their contributions.

If the beneficiary has already spent the money, or they are involved in a lawsuit or divorce, turning over the TOD/POD assets may get complicated. Other personal assets may be attached to make up for a shortfall.

If the beneficiary is receiving means-tested government benefits, as in the case of an individual with special needs, the TOD/POD assets may put their eligibility for those benefits at risk.

These and other complications make using a POD/TOD arrangement riskier than expected.

A trust provides a great deal more protection for the person creating the trust (grantor) and their beneficiaries. If the grantor becomes incapacitated, trustees will be in place to manage assets for the grantor’s benefit. With a TOD/POD, a Power of Attorney would be needed to allow the other person to control of the assets. The same banks reluctant to hand over a POD/TOD are even more strict about Powers of Attorney, even denying POAs, if they feel the forms are out-of-date or don’t have the state’s required language.

Creating a trust with an experienced estate planning attorney allows you to plan for yourself and your beneficiaries. You can plan for incapacity and plan for the assets in your trust to be used as you wish. If you want your adult children to receive a certain amount of money at certain ages or stages of their lives, a trust can be created to do so. You can also leave money for multiple generations, protecting it from probate and taxes, while building a legacy.

Reference: Kiplinger (Dec. 2, 2021) “TOD Accounts Versus Revocable Trusts—Which Is Better?”

What Happens to an HSA when Owner Dies?

“Do you know what happens to your HSA after you die? Health savings accounts, called HSAs for short, function differently than most other kinds of accounts.”

An HSA, or Health Savings Account, can be an excellent way to save for medical expenses. For wage earners with high-deductible HSA-eligible health insurance plans, the IRS allows generous contributions on a pre-tax basis to an HSA ($3,600 per year for individuals, $7,200 per year for a family plan as of 2021), according to the article “HSAs and Estate Planning” from The Street. The money can be withdrawn, including both principal and earnings, with no taxes, as long as the withdrawals are used for qualified medical expenses.

Seems like a no brainer, doesn’t it? This unique account allows for triple-tax savings. However, when HSAs become large, savvy planning is needed to understand how they work in estate planning and taxes. Here’s a look at what happens to an HSA when the owner passes.

The inherited HSA becomes the surviving spouse’s HSA, if the spouse had been designated as the beneficiary on the HSA. The money remains in the HSA and the spouse’s name is added to the account. They may make tax-free distributions from the HSA to pay for their own qualified medical expenses, as if they were the original owner. The HSA is not included in the estate, since it has become the property of the surviving spouse.

What if a non-spouse is the designated beneficiary? Upon the death of the original owner, the HSA is no longer considered an HSA for tax purposes. An immediate and taxable distribution of the entire amount goes to the non-spouse beneficiary. The beneficiary must include the HSA balance in their taxable income in the year of the original owner’s death.

The normal 20% penalty applying to distributions for non-qualified medical expenses doesn’t apply.  The beneficiary pays income taxes at their marginal tax rate on the full amount of the HSA balance.  However, at least there are no penalties.

However, any portion of an inherited HSA balance used to pay for outstanding medical expenses of the account owner within one year of the date of death (DOD) is not taxable to the non-spouse beneficiary. In this case, the HSA is also not included in the estate, since it is fully taxed to the non-spouse beneficiary on their own individual tax return.

If the HSA owner designates their estate as the beneficiary, the account balance is included in the owner’s gross income for the year of their death. The HSA is still not included in the estate and is treated as income for the last year of their life, when it is reported as income on the final tax return.

A charity may be listed as a beneficiary for a HSA. Any charity will receive the full amount of the HSA with no taxes or penalties.

For most people, it’s best to use the HSA as you need it. Once you reach age 65, you are no longer subject to the 20% penalty for withdrawals not spent on medical expenses. If you have a sizable HSA, talk with your estate planning attorney on how to efficiently use it, while living and for other beneficiaries after you have died.

Reference: The Street (Dec. 9, 2021) “HSAs and Estate Planning”