What You Should Know About Medicare and HSAs
Did You Know That Your HSA Contributions Must Stop When You Enroll In Medicare?
Excerpts from an article in Making Sen$e by Philip Moeller
The rise of high-deductible employer health plans has created one of the most unpleasant surprises for older employees: anyone on Medicare is no longer allowed to make tax-free contributions to a health savings account (HSA). As well, anyone age 65 or older receiving Social Security benefits must, by law, also be signed up for Part A of Medicare. This requirement, seemingly unrelated to their health plan, will also end their ability to make HSA contributions.
In 2003, Congress authorized HSAs as part of the law that also brought Part D drug plans into existence. HSAs are only available to those with a high-deductible health plan. The beauty of an HSA is that it is funded with pre-tax dollars and its holdings can be invested, like a 401(k). When spent, any earnings on these investments also are exempt from income taxes, like a Roth IRA, so long as the expenditures are for qualifying medical expenses. Unlike flexible spending accounts, HSA contributions do not have to be spent by the end of each year but can be carried over indefinitely.
There are minimum deductions needed for a health plan to qualify as high-deductible, and they may change each year. For 2018, plans must have an annual deductible of at least $1,350 if they cover individuals and $2,700 for families. Further, such plans may not generate out-of-pocket expenses that exceed $6,650 for individual plans and $13,300 for family coverage. These expenses, the IRS says, include plan “deductibles, co-payments, and other amounts, but not premiums.”
The annual maximum on these contributions in 2018 will be $3,450 for HSAs linked to individual insurance plans, and $6,900 for family plans. In addition, $1,000 age-related “catch up” contributions are permitted for those aged 55 or older. This raises the total limits of plan contributions to as much as $8,900. Employers often contribute some of these funds. But if you’re really scratching your head for that perfect holiday gift, it turns out that contributions to a plan can come from family and friends as well as the insured individuals.
While most HSAs are linked with employer insurance plans, any qualifying high-deductible plan can permit the insured person or family to open an HSA. This includes private health plans and those sold through Affordable Care Act exchanges. Employer plans generally set up HSAs for participating employees, but people also can work with financial institutions to create HSAs.
Medicare and Social Security enter the HSA picture because Medicare insurance is not a high-deductible health plan. So, anyone with Medicare, or coverage from other health plans that don’t offer qualifying high deductibles, may not contribute to an HSA. They can continue to use any assets within an existing HSA account, but may not make new ones.
The following are some FAQs on this subject:
Why does getting Social Security prohibit me from contributing to my HSA?
The law requires anyone aged 65 or older who is receiving any type of Social Security benefit to also be enrolled in premium-free Part A of Medicare, which covers hospital expenses. This triggers the Medicare-related ban on HSA contributions. Historically, getting Part A was a very good thing. It can be used as secondary insurance for people covered by employer health plans and charges no premiums to anyone who qualifies for Social Security benefits. The rise of high-deductible health plans, however, can make Part A a dubious benefit. Unfortunately, the only way to reject Part A is to withdraw from receiving Social Security benefit payments.
Why does Part A take effect six months before I get it? How am I supposed to know that I have to stop my HSA contributions even before I get Part A?
The earliest that a non-disabled person can enroll in Medicare is age 65. If you enroll in Medicare within six months of turning 65, Smith says, your Medicare [Part A in this case] will start on the first of the month in which you turn 65. If you enroll in Medicare after turning 65, you are entitled to as many as six months of retroactive benefits, but in no case can your effective date be earlier than when you turned 65.
Historically, people were better off with these retroactive benefit dates. Clearly, that may not be the case when it messes with their HSA program. Keep in mind however that people who claim Social Security benefits before they turn 65 are too young to qualify for Part A. So, claiming Social Security doesn’t always mess with your HSA – only if you’re 65 or older.
If I know I’m going to become ineligible for HSA contributions during a calendar year, can I “front load” that year’s allowable contributions before I become ineligible?
Unfortunately, no. It’s important to remember that contributions to an HSA are really calculated monthly. For example, if someone with family coverage had $6,900 contributed to his or her HSA, the rules “credit” one-twelfth of that amount each month, or $575. Normally, it wouldn’t matter if the person made all those contributions in January, for example, because the rules assume they would qualify for HSA contributions for the entire year. But if they became ineligible in July, say, then they would only be able to contribute $3,450 (six $575 monthly contributions).
What happens to any excess contributions?
They need to be removed from your HSA and treated as taxable income on your annual tax return. These rules are explained in IRS Publication 969 in which there are some taxpayer examples there that may be useful.
What happens to my employer’s contributions?
If we revisit the example where only six month’s of an employee’s $6,900 can be placed in the HSA here’s what happens. Let’s further say that this person’s employer has made a commitment to contribute, say, $1,500 during the year to the employee’s HSA. It is legal to permit the employer’s full annual contribution. In this example, the employee would contribute only $1,950 during the year, which is the maximum of $3,450 for six months, minus the employer’s $1,500 contribution.
What if I have family coverage and only one of us becomes ineligible?
If one spouse becomes ineligible, the full amount of that year’s family HSA contributions normally still can be made by the eligible spouse. The $6,900 can be contributed in any way the couple likes. If the ineligible spouse was making a $1,000 catch-up contribution, this will no longer be allowed. One important requirement here is that if the employee is the person who gets Medicare and becomes ineligible, the spouse must have set up an HSA of their own to make the couple’s allowable contributions.
If my employer only offers the high-deductible plan, what do I do if I’m ineligible for an HSA?
If you want employer health insurance, you will need to accept the likelihood that your out-of-pocket expenses could be substantial if you can’t offset your spending with HSA funds. People tripped up by getting Part A of Medicare should take a close look at whether it makes sense for them to reject their employer’s health plan and, instead, purchase Part B and other Medicare coverage, including a Part D drug plan and either a Medicare Advantage Plan or a Medicare Supplement plan. Most Medicare Advantage plans come bundled with a Part D plan.
If I find out I’m ineligible, how does this affect my taxes?
If you have made excess contributions and can withdraw them by the time your taxes are due, there will not be a penalty due to the IRS. Otherwise, the penalty is 6 percent.
Will my employer report my ineligibility to the IRS?
No, that’s up to you. HSAs are tax vehicles, and reporting them to the IRS is mostly on the honor system. This is also true for any HSA-related penalty payments. If you don’t report them, the IRS will only know about a problem if it audits you. The odds of such an audit are very small, but if it does occur, you face getting hit with penalties and payment of what would be considered back taxes.
What tax forms should I use for these things?
Form 8889 is used for reporting your annual HSA activity. Form 5329 is used to report excess contributions. If you use a tax preparer, you should work with them on how to file these forms, including whether you need to amend any past-year tax returns that were filed before you learned that some of your HSA contributions in a past year were illegal.