Medical symbol with sunriseThe 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).

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 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 the rest of these funds. And, 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 through financial institutions. 

Medicare and Social Security enter the HSA picture because Medicare insurance is not a high-deductible health plan. Anyone with Medicare, or coverage from other health plans that do not offer qualifying high deductibles, may not contribute to an HSA. A person can continue to use any assets within an existing HSA account.

Most common questions:

Why does receiving Social Security prohibit a person from contributing to an 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 Medicare Part A, which covers hospital expenses. This triggers the Medicare-related ban on HSA contributions. Historically, enrolling in Medicare Part A was a very good thing. It can be used as secondary insurance for people covered by employer health plans with no premiums. The rise of high-deductible health plans can make Medicare Part A a dubious benefit. Unfortunately, the only way to reject Medicare Part A is to withdraw from receiving Social Security benefits.

Why does Medicare Part A take effect six months before an individual’s requested effective date? And, how does a person know when to stop HSA contributions?

The earliest that a non-disabled person can enroll in Medicare is age 65. If enrolling in Medicare within six months prior to turning 65, Medicare Part A will start on the first of the month when turning 65. If enrolling in Medicare after turning 65, a person is entitled to as many as six months of retroactive benefits, but in no case can the effective date be earlier than when turning 65.

Historically, people were better off with these retroactive benefit dates. Clearly, that may not be the case when it conflicts with an HSA. 

People who claim Social Security benefits before they turn 65 are too young to qualify for Medicare Part A. Claiming Social Security does not always interfere with an HSA – only if a person is 65 or older.

If a person knows they are going to become ineligible for HSA contributions during a calendar year, can they “front load” that year’s allowable contributions before becoming ineligible?

No. It’s important to remember that contributions to an HSA are calculated monthly. For example, if someone with family coverage had $6,900 in allowable HSA contributions, the rules “credit” one-twelfth of that amount each month, or $575.

Normally, it would not 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, 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 the HSA and treated as taxable income on the annual tax return. These rules are explained, albeit not always clearly, in IRS Publication 969

What happens to the employer’s contributions?

The employer has made a commitment to contribute, for example, $1,500 for the year to the employee’s HSA. It is legal for the employer to contribute a full annual contribution. In this example, for a period of six months, the employee’s allowed contributions would be $1,950 in addition to the employer’s $1,500 contribution.

It is the responsibility of the employee to make sure there are no excess contributions. If there are, it’s the responsibility of the employee to correct it before filing that year’s tax return. If the employer does not have knowledge of the employee becoming ineligible for additional HSA contributions, there is no reason why the employer’s contribution should terminate.

What if a person has family coverage and one family member becomes ineligible?

If one spouse becomes ineligible, the full amount of that year’s family HSA contributions normally can be made by the eligible spouse. The $6,900 can be contributed in any way the couple prefers. If the ineligible spouse was making a $1,000 catch-up contribution, this would no longer be allowed.

One important requirement is that if the employee is the person who begins Medicare and becomes ineligible, the spouse must have established their own HSA in order to complete the couple’s allowable contributions.

Is there was a family HSA for people with family health coverage?

There are no joint HSAs. Each spouse must have their own HSA if they wish to make tax-free contributions. This most often happens where the non-employee spouse wishes to make an age-related catch-up contribution of $1,000. That contribution can only be placed in their HSA account. Employers usually do not create such accounts, so the non-employer spouse needs to work with a financial firm to establish the account. There are ongoing efforts to revise HSA laws and eliminate the need for non-employee spouses to create separate HSAs for their catch-up contributions.

If an employer offers only the high-deductible plan, what can a person do if they are ineligible for an HSA?

If a person wants employer health insurance, they will need to accept the likelihood that out-of-pocket expenses could be substantial without HSA funds.

People with Medicare Part A should take a close look at whether it makes sense for them to reject their employer’s health plan and, instead, purchase Medicare Part B and other Medicare coverage, including a Medicare Part D drug plan with an optional Medigap supplement plan or a Medicare Advantage plan. 

If ineligible, how does this affect income taxes?

If a person has made excess contributions and can withdraw them by the time income taxes are due, there will not be a penalty due to the IRS. Otherwise, the penalty is 6 percent.

What tax forms should be used?

Form 8889 is used for reporting your annual HSA activity. Form 5329 is used to report excess contributions. If using a tax preparer, work with them on how to file these forms.