Many Americans spend years building savings in a Health Savings Account (HSA), one of the most tax-advantaged ways to save for health care expenses. HSA funds can be used for many qualified medical expenses, including deductibles, copays, coinsurance, prescription medications and certain medical equipment… even when you are on Medicare. That is why HSAs can be such an important part of your retirement planning.
But when Medicare enters the picture, the rules can lead to unexpected tax consequences.
Where Medicare Can Create a Problem with HSAs
Some people continue working after age 65 and remain covered by an employer-sponsored HSA-eligible high-deductible health plan (HDHP). That's allowed. Simply turning 65 or becoming eligible for Medicare doesn't automatically prevent you from contributing to an HSA. The issue begins when you are actually enrolled in Medicare.
Once you're enrolled in Medicare Part A and/or B, you generally can no longer contribute to an HSA.
The confusion is that Medicare enrollment doesn't always happen when people expect it to.
One way this can happen is through Social Security benefits. If you're already receiving Social Security benefits when you become eligible for Medicare, you're generally automatically enrolled in Medicare Part A and Part B. While Part B can generally be declined, premium-free Part A usually takes effect automatically. Once Part A coverage begins, you're no longer eligible to contribute to an HSA, even if you're still working and covered by your employer's HSA-eligible health plan.
That means someone could continue making HSA contributions through payroll, or continue receiving employer contributions, without realizing that Medicare coverage has kicked in and made them ineligible to make those contributions.
A second issue can arise when someone delays Medicare while continuing to work and contribute to an HSA. When that person later applies for premium-free Medicare Part A after age 65, their Part A coverage can generally be retroactive for up to six months, but not earlier than the month they first became eligible for Medicare.
This creates a potential HSA problem because a person can't make HSA contributions for months in which they're covered by Medicare. If Part A is applied retroactively, HSA contributions made for those retroactively covered months may become excess contributions, even though the person wasn't aware at the time that Medicare coverage would later reach back to those months.
For example, someone who works past 65, keeps an HSA-eligible employer plan and delays Medicare might continue contributing to an HSA. If they later enroll in Medicare and receive six months of retroactive Part A coverage, some of those recent HSA contributions may no longer be allowable.
That's why it's important for people who work past 65 to coordinate the timing of Medicare enrollment, Social Security benefits, and HSA contributions.
The Potential Tax Consequences
The IRS generally imposes a 6% excise tax on these “excess” HSA contributions that aren't corrected as permitted under IRS rules. The tax can apply for each tax year the excess remains in the account.
In some cases, an individual may be able to avoid the 6% excise tax by withdrawing the excess contribution, along with any earnings attributable to it, by the applicable tax-return deadline and properly reporting the correction.
Because the tax treatment depends on the circumstances and timing, anyone who discovers a possible excess contribution should consider contacting the HSA custodian and a qualified tax professional.
How to Avoid HSA Contribution Problems
If you're approaching Medicare eligibility, planning to enroll in Medicare, or applying for Social Security benefits after age 65, review your HSA contribution strategy ahead of time. The correct time to stop contributing isn't the same for everyone.
For example, if you enroll in Medicare during your Initial Enrollment Period, you generally need to make your last HSA contribution for the month before your Medicare Part A coverage begins. Special rules can apply if your birthday is on the first day of a month.
If you delay Medicare and later enroll in premium-free Part A, Medicare recommends accounting for the possibility that Part A coverage will be retroactive. If you enroll six or more months after turning 65, that generally means stopping HSA contributions six months before the month you apply for Medicare or Social Security benefits.
Because enrollment dates and individual circumstances can vary, confirm the effective date of your Medicare coverage before determining your final HSA contribution.
Your HSA Can Still Be Valuable After Medicare
Enrolling in Medicare means you can no longer make HSA contributions, but it doesn't mean you can't use the money already in your account. You can continue pulling from your HSA after enrolling in Medicare, and withdrawals for qualified medical expenses can generally remain tax-free. HSA funds can therefore continue to be a valuable resource for health care expenses throughout retirement.
The key is planning ahead. Understanding when Medicare coverage begins, and when HSA contributions must stop, can help you preserve the tax advantages you've worked to build.
