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A Health Savings Account (HSA) is a powerful tool for employees to save money. It can be used to cover qualified medical expenses such as deductibles, co-pays, dental and vision expenses, and prescription drugs. As contributions are made to the account, the account balance grows, and can be utilized in retirement as well.
HSAs must be paired with a qualified high deductible health plan (HDHP). An employee can contribute pre-tax dollars, pay no taxes on earnings, and withdraw tax-free funds to pay for eligible medical expenses. The account balance rolls over annually, allowing funds to grow, and to provide individuals with a potential retirement nest egg.
Rules and Penalties
Medicare was established by the federal government to provide health insurance coverage to Americans age 65+ and those living with chronic conditions or are disabled. For those individuals with HSAs, it’s important to understand the rules when it comes to contributing to it before, during, and after Medicare enrollment.
If an employee had an HSA prior to being enrolled in Medicare, they can use the funds from that account. To contribute to an HSA, an individual must be enrolled an HSA-eligible health plan and not be covered by other insurance, such as Medicare. Once an individual enrolls in Medicare, they are no longer eligible to contribute to an HSA, which includes both employee and/or employer contributions.
If an individual delays Medicare since they’re still working, are enrolled in their current employer’s group health plan and enroll in Medicare after age 65, there is a 6-month lookback period to be aware of.
During this window, individuals cannot make HSA contributions, as they can receive retroactive Medicare health coverage. To avoid penalties, it’s advised to stop contributing to an HSA six months before enrolling in Medicare. The month of application is what is used to calculate the 6-month lookback period and not the month they begin Medicare coverage. Note, if individuals begin collecting Social Security, this will automatically enroll them in Medicare Part A.
Contributing to an HSA while an individual is enrolled in Medicare may subject them to IRS penalties. These are considered “excess contributions” and includes a 6% excise tax charge.
For example, if an employee is retiring on August 31st and they apply for Medicare in September, the 6-month lookback period would run from March-August, so all employer and/or employee HSA contributions should cease after February. Individuals should also keep in mind annual HSA contribution limits, as these come into play as well. Using 2024 HSA contribution limits for an individual on single health coverage, the maximum they could contribute to the HSA in 2024 would be $858.33 ($4,150 individual limit + $1,000 catch-up contribution x (2/12)).
Once an individual is over age 65 and enrolled in Medicare, HSA savings can be used to pay certain premiums if the individual is separated from service. This includes Medicare Parts A, B, C, and D, but not Medicare Supplement insurance premiums. Prior to age 65, if an individual is separated from service, HSA funds can also be used for COBRA premiums. This is why HSAs can be such a great retirement vehicle, especially if you’re looking to retire early.
In addition to medical expenses, upon attaining Medicare Eligibility Age, individuals can also use their HSA, penalty free, to pay for any non-medical expenses, such as a vacation or a new car. However, these non-medical distributions are subject to state and federal taxes. If an individual is not enrolled in Medicare and makes a non-medical purchase, they would be subject to taxes and a 20% penalty, unless disabled.
If an individual is still covered under their employer’s group health insurance, they can elect to delay their enrollment into Medicare Part A and B and continue making contributions into their HSA. If they elect to delay their Medicare enrollment, they will also need to do the same with Social Security as a person is automatically enrolled in Medicare Part A at that time.
For more information about HSAs and Medicare, please contact your NIS Representative.
National Insurance Services is not a law firm and no opinion, suggestion, or recommendation of the firm or its employees shall constitute legal advice. Readers are advised to consult with their own attorney for a determination of their legal rights, responsibilities and liabilities, including the interpretation of any statute or regulation, or its application to the readers’ business activities.