Medicare Rules and HSA’s

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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.

 

 

HSAs/HDHPs – Working Together

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Smiling Pleasant LadyIt’s no secret that health care costs have been skyrocketing for many years and that the rapid rate of increase is affecting everyone. It’s estimated that a couple retiring today at age 65 will need $200,000 to cover health care expenses in retirement. 

That means saving for health care should be an important part of retirement planning.

There is an approach that can help you better plan for and meet these rising costs— enrollment in an HSA-eligible health plan (also known as a High-Deductible Health Plan [HDHP]) and an HSA. This combination can potentially save you money on health care while giving you more control over how your medical dollars are spent.

To help you better understand HSA-eligible health plans, HSAs, and how the two work together, here are answers to some commonly asked questions to help you get started.

What is an HSA-eligible health plan?

An HSA-eligible health plan is an HDHP that satisfies certain IRS requirements with respect to deductibles and out-of-pocket expenses. You generally pay more up front for medical expenses before the plan begins to pay for covered services. In return, you will generally pay less in premiums than in other medical plan options. Otherwise, an HSA-eligible health plan is much like a traditional health care plan. Enrollment in an HSA-eligible health plan is one of the requirements to be eligible to establish an HSA.

What is an HSA? – A Health Savings Account (HSA) is an individual account used in conjunction with an HSA-eligible health plan to cover out-of-pocket qualified medical expenses on a tax-advantaged basis. Your HSA belongs entirely to you and can be used to pay for both current and future qualified medical expenses for you and your eligible dependents. You can contribute to your account, withdraw contributions to pay for current qualified medical expenses, and potentially grow your account on a tax-free basis by investing your savings in a wide array of investment options.

Why should you consider an HSA? – If you have the opportunity to enroll in an HSA-eligible health plan with an HSA, you may want to take a closer look. This combination may offer some significant tax and savings advantages over traditional health care plan options—no matter if you’re a low, medium, or high user of health care services.

Control. You determine how much to contribute (up to your maximum annual contribution limit per IRS rules), when and how to invest your contributions, and whether to take an HSA distribution to pay for current qualified medical expenses, or let your contributions stay invested for future growth potential.

Tax savings. When used for qualified medical expenses, HSAs offer a triple tax savings—contributions, any investment earnings, and distributions are federal tax free.

Growth potential. You have the opportunity to invest your contributions in a wide array of investment options—including stocks, bonds, and mutual funds—for potential growth of your account over time.

Flexibility. Any unused balance in your account will automatically carry over from year to year so you can begin to build your savings for future qualified medical expenses.

Portability. Your HSA always belongs to you, even if you change jobs or become unemployed, change your medical coverage, move to another state, or change your marital status.

Who is eligible to open an HSA? – You must meet several IRS eligibility requirements in order to establish and contribute to an HSA. It is your responsibility to determine if you are eligible:

  • You must be enrolled in an HSA-eligible health plan on the first day of the month. For example, if your coverage is effective on May 15, you are not eligible to contribute to or take a distribution from your HSA until June 1.
  • You cannot be covered by any other health plan that is not an HSA-eligible health plan.
  • You cannot currently be enrolled in Medicare.
  • You cannot be claimed as a dependent on another person’s tax return.

If you open an HSA and do not meet the above criteria, your contributions, any investment earnings, and distributions may be subject to income taxes, penalties, and/or excise taxes. Additionally, in order to open and contribute to an HSA, you must have a valid U.S. address.

How does a person know if an HSA is right for them? – While many may benefit from an HSA, your personal situation will determine if an HSA-eligible health plan and HSA are the right approach to meet your health care needs. As you explore your options, consider your anticipated health care expenses, your current financial situation, and how much control you want over your medical spending. Keep in mind that HSAs come with the additional responsibility to track, manage, and monitor your health care and related expenses. The record-keeping of your HSA is up to you, and it’s important to hold on to all receipts, records, or other documentation as proof that the expenses you pay from your HSA are for qualified medical expenses.

What type of expenses does an HSA cover? – Distributions from an HSA used to pay for qualified medical expenses for you, your spouse, and dependents are tax free provided they meet the IRS definition of a qualified medical expense. The good news is that a lot of expenses qualify for payment or reimbursement, such as:

  • Health plan deductibles and coinsurance
  • Most medical care and services
  • Dental and vision care
  • Prescription drugs and insulin
  • Long-Term Care Insurance premiums

Note that these expenses must not already be covered by insurance and that health insurance premiums generally do not qualify. For more information about HSAs and qualified medical expenses, refer to IRS Publications 969 and 502 at http://www.irs.gov or consult a tax professional.

Should an HSA be used to pay current qualified medical expenses or be saved for the future? – An HSA is your personal account and only you can choose how to use it. You can use the funds in your account as you incur qualified medical expenses, or leave your contributions in your HSA and pay for current medical expenses out of pocket.

Why would you want to do this? The combination of HSA tax advantages and the variety of investment options available through many HSAs provide an opportunity for potential growth. Consider this hypothetical example:

If you contributed $3,000 annually to an HSA and earned a 7% return over a 20-year period, you could potentially grow your balance to $127,291— that’s $60,000 from your own contributions plus $67,291 in earnings that you can use to pay for qualified medical expenses, free from federal taxes.

 

 

 

Social Security at 80: Eight Savings Strategies

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Social Security 80

Social Security celebrated its 80th birthday on August 14, 2015. And while news about the program’s financial status is rarely upbeat, most Americans are glad it still exists especially women and lower-earning workers.

Here’s why you need to pretend it doesn’t exist: Underfunded as it is, Social Security remains a favorite political football. At the same time, we’re living longer, and our savings need to last. So whatever happens to Social Security, it’s more important than ever to use all the savings strategies at your disposal.

Here are 8 ways to do that, one for each decade of Social Security.

1. Make savings simple

Just how important will your personal savings be in retirement? According to the National Academy of Social Insurance, a non-profit group that focuses on “how social insurance contributes to economic security,”  the Social Security program replaces more than 50 percent of income for low-earning workers. Furthermore, high earners would need to radically reduce their lifestyle if they need to rely heavily on Social Security income in retirement.

The Social Security Administration calculates income replacement rates for retired workers across a range of income scenarios, from those with very low income to those who hit the maximum annual amount of income taxed by Social Security (in 2015, it’s $118,500).  Their calculations assume 35 years of contributing to the program and are based on Social Security’s national average wage index (AWI). For 2015, the average is $47,820.

If you’re lucky enough to be at a company that offers a 401(k), you may already be funneling money into it every pay period. Maybe you can even save enough to get all of the company match, if there is one. Saving 12 to 15 percent of your salary in a 401(k), up to the 2015 contribution limit of $18,000, is a very good idea.

That assumes you already have a cash emergency fund of three months at the very least. If your budget allows, try setting up automatic deductions from your checking account into other savings accounts, even if it’s just $25 or $50 a paycheck. And if you don’t notice that it’s gone, kick the contribution up a little higher.

2. Keep 401(k) savings sacrosanct 

One challenge millennials face that their parents didn’t is handling 401(k) accounts while moving jobs every two to three years. Rather than roll an old 401(k) into a new employer’s plan, many young savers just cash it out, which means paying income tax on it and a 10 percent penalty.

In the fiscal year of 2014 that ended on March 31, more than 40 percent of 401(k) participants between the ages of 20 and 29 cashed out all or part of their plan balance after leaving a job, according to Fidelity. Even for those between the ages of 40 and 49, the cash-out percentage was high, at 32 percent.

Barring a lottery win or a fat inheritance, starting to save early, so money can compound over many decades, is really the only way most younger savers are going to arrive at retirement age with a decent nest egg.

3. Wage war on fees 

This means, first, knowing what fees you are paying for different investment accounts. Many people have no idea, particularly when it comes to retirement savings accounts such as 401(k) plans. A Department of Labor rule saying plans must provide participants with fee disclosure has made that information more easily available.

Once you find that information, your plan probably won’t note whether those fees are low, average, or high compared to similar funds. You can get a rough sense of it at brightscope.com.

4. Check your asset mix

If you have multiple investment accounts outside your 401(k), or just multiple 401(k)s, it can be hard to know what percentage of your assets are in cash equivalents, bonds, and stocks. What is the optimal mix?

Everyone’s situation and risk tolerance are different, but the asset allocation in target-date funds gives a sense of what some large investment companies think is ideal.

5. Know your risk tolerance 

To guard against getting too stressed by market swings, investors may want to separate their money in different buckets. Money can be tied to short-, medium- and long-term goals, with each bucket having a different risk profile.

6. Be an employee benefits ninja

If you’re offered a flexible spending program or the ability to pay your commuting costs with pre-tax money, take the time to learn about them. You’ll get more mileage out of your money and lower your income taxes to boot. Making the most of tax-advantaged perks is a small way to give yourself a raise in a time of stagnating wages.

Employers have been shifting more costs to employees, often through the use of high-deductible health-care plans. Companies’ adoption of such plans may slow next year, according to a survey of more than 100 large U.S. employers. Employers are waiting to see if lawmakers repeal Obamacare’s “Cadillac tax” on high-cost health coverage, which is a levy on individual health premiums greater than $10,200.

Health care savings accounts (HSAs), which go hand-in-hand with high-deductible health plans, will likely become a greater part of employee’s lives. These are “triple tax-free”—what you put in is sheltered from income tax, it grows tax-deferred, and the money can be used, tax-free, for medical expenses. Companies usually seed the accounts with a few hundred dollars, pre-tax, and your contributions are tax-deductible. You can contribute up to $3,350 for an individual policy and $6,650 for a family plan. And unlike flexible-spending programs, they are not “use it or lose it,” so your money accumulates.

7. Ignore the fancy stuff 

There are many benefits to keeping your finances fairly simple, like having a clear picture of where you stand. Unless you’re a seasoned speculator whose retirement is already more than provided for, avoid any investment with the word “leverage” or 2x or 3x (or more) in its name.  It’s been said before, but bears repeating: If you don’t understand it, don’t buy it.

8. Eat your spinach 

Health care costs in retirement are the most likely expense to send your finances into the depths of abyss. Fidelity estimates that in 2014 a couple who retired at age 65 could look forward to $220,000 (in today’s dollars) in health care costs. That number didn’t rise from 2013, but it’s still way more than most people have saved for all of their retirement.

The AARP has a pretty simple calculator, and there are many others, that will scare you into the gym if you aren’t there already. It’s like making money!