Health Savings Accounts and Medicare Beneficiaries

Health Savings Accounts (HSAs) Defined

Health Savings Accounts (HSAs) are savings accounts that allow consumers to put money aside to pay for certain “qualified health expenses” on a tax-free basis. HSAs are used in tandem with high deductible health plans (HDHPs), which are health insurance plans that require high deductibles to be paid prior to triggering insurance coverage. By requiring the payment of significant out-of-pocket costs upfront, HDHPs theoretically encourage consumers to make cautious health care purchasing decisions and avoid unnecessary or excessive care.  This may, however, actually make consumers question whether care is appropriate, and forgo needed treatment. To ease the financial burden of these high up-front costs, HSAs are used in conjunction with HDHPs to make tax-free healthcare purchases while spending toward the high deductible.

Eligibility to Setup an HSA

Anyone who is enrolled in an HDHP (or has coverage through a family member’s HDHP) is eligible to setup an HSA. IRS rules, however, prohibit the active use of HSAs when one has a plan other than an HDHP.[1] The reasoning is that those in non-HDHP plans do not face the same high out-of-pocket cost burdens to justify tax relief. Therefore, if one has any form of coverage other than a HDHP (including dual coverage under a non-HDHP plan), they are ineligible to setup an HSA.

Setting Up HSAs While Enrolled in Medicare

Medicare Part A and B plans are not considered HDHPs and therefore individuals cannot setup an HSA after they are enrolled in Medicare.[2] One can however continue to withdraw from an existing HSA while on Medicare (with limitations, as explained below).

Retaining HSAs While Enrolled in Medicare

While Medicare beneficiaries cannot set up HSAs after they are enrolled in Medicare, they may keep an HSA if it was in existence prior to Medicare enrollment. For example, an individual previously covered under an employer’s HSA+HDHP plan who chooses to retire may keep the HSA even after terminating the HDHP coverage and enrolling in Medicare. Alternatively, an individual who chooses to keep an HSA+HDHP plan (or remain in a spouse’s HSA plan) and dually enroll in Medicare may keep the HSA.  However, individuals may not continue to contribute funds to the HSA if enrolled in Medicare (or other, non-HDHP plan).[3]

Using HSAs While Enrolled in Medicare

If a beneficiary chooses to keep a HSA after enrolling in Medicare, he or she may continue to withdraw existing funds from the account to pay for “qualified medical expenses” on a tax-free basis.[4]  Qualified medical expenses are defined by the IRS and include a large range of health care services, medications, and equipment. The definition also includes Medicare premiums and copays, a valuable way for Medicare beneficiaries to make use of their unused HSA funds. (Note, however, that premiums for Medicare supplemental policies, also known as Medigap plans, are excluded from the definition and cannot be paid from an HSA).[5]

While Medicare beneficiaries can continue to withdraw funds from their existing HSA, they cannot continue to make tax-free contributions to the account once they are enrolled in Medicare. Medicare beneficiaries may use existing HSAs to pay for qualified medical expenses until funds are exhausted, at which point the HSA is no longer of use.[6]  

Consequences of Contributing Funds to an HSA When Enrolled in Medicare

Medicare beneficiaries who continue to contribute funds to a HSA may face IRS penalties including payment of back taxes on their tax-free contributions and account interest, excise taxes, and additional income taxes.[7]

Contributions to an HSA are made on a pre-tax basis; Medicare beneficiaries will be subject to payment of back taxes on any contributions made to the account after their date of Medicare enrollment. The contributions may also be considered “excess contributions” by the IRS and subject to an additional 6% excise tax when those funds are withdrawn. Furthermore, the beneficiary could be subject to a 10% income tax if they enroll in Medicare during their “testing period” for the HSA.[8]

Individuals receiving Social Security benefits will be automatically enrolled in Medicare Part A upon turning 65. Thus they must pay particular attention to HSA rules. The HSA trustee in charge of administering the plan may or may not be aware of the individual’s new Medicare enrollment. Some HSA trustees may have the ability to lock the beneficiary’s account from any additional contributions, but this is not always the case. It is therefore incumbent on the beneficiary to be aware of the consequences and immediately cease contributing to their HSA upon their date of enrollment in Medicare.

Example: Mr. K. has been receiving Social Security benefits since he turned 62 in 2014. He turns 65 in March 2017. He should stop contributing to his HSA in February 2017.

Individuals who turn 65 but are not yet receiving Social Security benefits must take affirmative steps to enroll in Medicare. They must stop making HSA contributions for up to 6 months before enrolling in Medicare.

The IRS will consider an individual to have had Medicare (non-HDHP) coverage during those retroactive benefit months for purposes of HSA contribution rules. Thus any contributions made during the retroactive period will be subject to the same IRS penalties as someone who contributed after their Medicare enrollment date. Therefore, it is critical that prospective Medicare beneficiaries stop contributing to an HSA up to 6 months prior to enrolling in Medicare. For example:

Example 1: Mr. G. turns 65 in March 2017. He plans to retire in June 2017. He should stop contributing to his HSA in February 2017.

Example 2: Ms. S. turns 65 in March 2017. She plans to retire in July 2018. She should stop contributing to her HSA in December 2017.

Contesting Penalties for Contributions Made During the Medicare Retroactive Period

Individuals have no recourse to contest the penalties after they’ve been imposed by the IRS. Steps can be taken, however, to prevent penalties for ineligible contributions. An individual beneficiary can withdraw any contributions made while ineligible for an HSA without penalty if they:

1. Withdraw the contributions by the due date of the tax return for the year the contributions were made, and
2. Withdraw any income earned on the withdrawn contributions and include the earnings on their tax return.[9]

Conclusion

Individuals who have an HSA who will qualify for Medicare must be cognizant of HSA rules and ensure that they cease making contributions at the appropriate time in order to avoid tax penalties. While previously established HSAs can provide valuable advantages to Medicare beneficiaries, such as paying for Medicare cost-sharing and out-of-pocket costs, HAS contributions must stop prior to enrollment in Medicare. Indeed, such contributions could result in significant financial penalties.

March 1, 2017 – A. Roozbehani