On the surface, the interaction between health savings account (HSA) eligibility and Medicare eligibility may seem simple—once an individual becomes eligible to receive Medicare benefits, he or she is no longer eligible to contribute to an HSA. An advisor who thinks this is the end of the story, however, could cause clients to become subject to substantial tax penalties. Unfortunately, the rule is more complex than it appears, and there are factors that could cause an individual who is not enrolled in Medicare to be subject to penalties for improper HSA contributions—just as there are ways that a Medicare-eligible individual can continue his or her HSA eligibility.
Because the penalties can be steep, it’s important that advisors have a full understanding of these important rules.
The Impact of Medicare on HSA Eligibility
As discussed above, once a client begins to receive Medicare benefits, he or she is generally no longer entitled to contribute to an HSA. This is the case whether the client is enrolled in Medicare Part A or Medicare Part B (or both).
However, some clients may not realize that Medicare Part A enrollment is automatic once the client begins receiving Social Security retirement benefits. If the client begins receiving Social Security benefits at least four months prior to turning age 65 (when he or she becomes eligible for Medicare), Medicare Part A enrollment is automatic.
In the year that the client initially becomes eligible for Medicare coverage, HSA contributions remain permissible for the portion of the year that he or she was not enrolled in Medicare. To determine the client’s maximum HSA contribution in this scenario, the client must divide the annual maximum HSA contribution limit by 12, and multiply that figure by the number of months that he or she was not enrolled in Medicare.
Any amounts that have already been contributed to the HSA can, of course, remain in the HSA and will be available for tax-free withdrawal to cover future medical expenses. These funds can also be used to pay for Medicare Parts B and D, as well as Medicare HMO premiums, tax-free, but cannot be used for Medigap premiums.
Further, if the client’s spouse has contributed to an HSA and enrolls in Medicare, but the client has not begun to receive Medicare coverage, the client can open his or her own HSA and continue to contribute as long as he or she remains covered by a high deductible health plan (HDHP).
Delaying Medicare Enrollment
Because Medicare enrollment precludes HSA contributions, some clients who are still working may wish to consider deferring Medicare enrollment. Despite this, clients need to know that deferring Medicare coverage can generate its own penalties.
In order to defer Medicare Part A coverage, the client must first refrain from claiming Social Security benefits. However, the client can only delay Social Security coverage for so long—until he or she reaches age 70. At that point, not only will Medicare Part A coverage become automatic, but the Social Security Administration provides six months’ worth of retroactive benefits—during which time the client will also be deemed to have Medicare coverage. As a result, the client must stop making HSA contributions six months before applying for Social Security benefits in order to avoid penalties.
In order to delay all types of Medicare coverage, the client must have health insurance provided by his or her employer, or a spouse’s employer, with more than 20 employees. The employer-provided health coverage must also provide prescription drug coverage that is “creditable” (i.e., similar to Medicare Part D coverage).