Enrolling in Medicare When You Have a Health Savings Account (HSA)
By Scott Snider
KEY TAKEAWAYS
Upon enrolling in Medicare Parts A and B, you are no longer eligible to contribute funds into your Health Savings Account (HSA).
Tax-free withdrawals from your HSA are still permitted while you are enrolled in Medicare.
HSAs can be used to pay premiums for Medicare Part B, C, and D, but cannot be used for Medigap premiums.
Delaying enrollment into Medicare in order to remain eligible for contributing to your HSA should be considered carefully – mind the details with your employer and if you are already receiving Social Security benefits.
Before we dive into the main components of this article, which is Health Savings Accounts (HSA) and Medicare, let’s do a brief primer on how these types of accounts operate. HSAs are tax deferred savings vehicles that allow contributions to go in tax-free, and for withdrawals to be taken out tax-free – as long as the money is used to pay for qualified medical expenses. Therefore, HSAs are truly the only triple tax savings accounts allowed by the IRS.
The key to qualifying for an HSA is that you must be enrolled in a high-deductible health plan (HDHP). Unfortunately, one of the drawbacks of HDHPs are the large deductibles. In other words, people with HDHPs pay in full for most health care services until they reach their deductible that year. For those with relatively low health care costs, an HDHP type of plan and an HSA is more suitable. A low deductible health plan (if available) is typically a better fit for someone who has a large amount of health care expenses due to a chronic condition.
For a deeper understanding of the main advantages of HSAs and other basics please refer to our article, Could a Health Savings Account (HAS) be THE best account to invest in?
What to Watch Out for with Health Savings Accounts and Medicare
Unfortunately, upon enrolling in Original Medicare (Parts A and B), you are no longer able to contribute pre-tax dollars to your HSA because Medicare is not an HDHP. This means that whenever you begin Medicare, it’s advisable to change your HSA contributions to $0 at least 6 months before you plan to sign up for Medicare. The reason why is that when enrolling in Medicare Part A, you receive up to 6 months of retroactive coverage. Failing to stop your contributions can lead to a tax penalty on any money you contribute while on Medicare. The level of penalty varies depending on the situation, but the most common issues that occur are:
Back taxes are owed on any contributions made after Medicare enrollment, and your contributions will be added back to your taxable income for the year.
Contributions while under Medicare could be considered “excess” by the IRS. What this means is that you will be taxed an additional 6% when you withdraw those contributions.
Back taxes plus a 10% IRS penalty applies if you enroll in Medicare during your HSA testing period. According to IRS Publication 969, the testing period begins with the last month of your tax year and ends on the last day of the 12th month following that month (for example, December 1, 2021, through December 31, 2022).
The Silver Lining
The good news is that you can continue to withdraw money from your HSA, tax-free, while you are enrolled in Medicare. So, if you have been diligently maxing out your HSA contributions on an annual basis over the years – and didn’t spend much leading up to when you transitioned to Medicare – you have the ability to tap into a sizable pool of funds to pay for medical expenses throughout your retirement. In addition, most HSA accounts offer you the option to invest the proceeds into mutual funds and index funds, thereby allowing you to grow the balance with compound interest. Not bad, eh…
What’s even better is that your Health Savings Account can be used to pay for:
Medicare deductibles
Co-payments and co-insurance associated with Medicare
Medicare Part B premiums
Medicare Part C premiums
Medicare Part D premiums
Dental and vision expenses
Insulin and diabetic supplies
Over-the-counter medicine
However, it’s important to be aware that Health Savings Accounts do not pay for Medicare supplement policies (Medigap). Additionally, if your Medicare premiums are directly paid from your Social Security benefits, you can still withdraw money from your HSA tax-free to reimburse yourself for those expenses.
What About Delaying Medicare Enrollment to Qualify for the Tax Benefits of an HSA?
The decision to delay Medicare in order to qualify for tax-free contributions into an HSA will greatly depend on your personal situation. The important aspect to consider here is knowing which type of employer you work for. If you work for a company with 20 or more employees, your health plan through the employer pays primary to Medicare. Therefore, you have the ability to delay Medicare enrollment and continue making contributions into your Health Savings Account.
On the other hand, if you work for an employer with fewer than 20 employees, you likely will need Medicare in order to have primary insurance. The reason being is that health coverage from employers with less than 20 employees pays secondary to Medicare. The consequence of failing to enroll in Medicare in this type of situation means you may have no health coverage because your health plan does not have to pay until after Medicare pays.
Something else to be aware of is that in either case, you have access to the Part B Special Enrollment Period whenever you lose coverage or retire.
Another nuance to consider, if you intend to delay enrolling in Medicare because you want to continue saving money into an HSA, is that you will need to wait to collect Social Security retirement benefits. Whenever an individual is already receiving Social Security benefits and they become eligible for Medicare, that person is automatically enrolled into Medicare Part A. Regrettably, you cannot decline Part A while receiving social security benefits.
Helpful Medicare Resources
If you didn’t catch the other articles in our Medicare series and care to learn more about how to navigate this important facet of your retirement, you can refer to our Medicare series page. Or if you are a more audio-visual learner, we created a course specifically designed to help you understand the basic elements of Medicare - watch our Medicare segment from The Retirement Continuum™ class recorded in 2020, here. The numbers are slightly outdated, but the overview and explanations are still applicable today.
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