Everything you want to know about Medicare’s rules on health savings accounts

Editor’s Note: Journalist Philip Moeller is here to provide the answers you need on aging and retirement. His weekly column, “Ask Phil,” aims to help older Americans and their families by answering their health care and financial questions. Phil is the author of the new book, “Get What’s Yours for Medicare,” and co-author of “Get What’s Yours: The Revised Secrets to Maxing Out Your Social Security.” Send your questions to Phil; and he will answer as many as he can.

The 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).

To the further consternation of many such employees, anyone age 65 or older receiving Social Security benefits must, by law, also be signed up for Part A of Medicare. This requirement, seemingly unrelated to their health plan, also will end their ability to make HSA contributions.

Almost from the first Ask Phil column more than three years ago, a steady flow of reader questions about Medicare and HSA rules has become a virtual hit parade of confusion and, often, anger.

Some of the confusion, unfortunately, came from me. I have reviewed past answers to HSA questions in preparing today’s piece. Even using a very charitable yardstick, some of them were, shall we say, less than models of clarity. So, please accept my mea culpa, and join this master class to explain this topic.

My instructor today is Dorian Smith, a partner and health consultant who advises employers on these and other matters for the large Mercer consulting firm. He patiently walked me through the details of how HSAs work, their Medicare snafus, and how IRS rules about HSAs can come into play here. If there are any flaws in the class, they are most certainly my doing and not his.

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 also 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 some of these funds. But if you’re really scratching your head for that perfect holiday gift, it turns out that 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 and those sold through Affordable Care Act exchanges. Employer plans generally set up HSAs for participating employees, but people also can work with financial institutions to create HSAs.

This is the case with non-employee plans and, as Smith notes, also what usually happens if the spouse of an employee with a company-enabled HSA wants to create their own HSA. Employers rarely create such spousal accounts. I will get back to spousal accounts in a bit.

Since 2004, the number of HSAs has soared, according to the Employee Benefit Research Institute, reaching estimated enrollment of at least 20 million and as much as 23.6 million. More than 7 million additional health-plan enrollees are eligible for HSAs but had not opened an HSA as of 2016, EBRI reported. With roughly a third of people aged 65 to 75 still in the work force, a substantial number of people with HSAs also qualify for Medicare and Social Security.

Medicare and Social Security enter the HSA picture because Medicare insurance is not a high-deductible health plan. So, anyone with Medicare, or coverage from other health plans that don’t offer qualifying high deductibles, may not contribute to an HSA. They can continue to use any assets within an existing HSA account, but may not make new ones.

It’s at this point in the story, that the Ask Phil mailbag erupts with questions, confusion, and not a little bit of anger. Here are the most common questions, purged of curse words:

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

Why does Part A take effect six months before I get it? How the heck am I supposed to know that I have to stop my HSA contributions even before I get Part A?

Welcome to Social Security’s laudable goal of helping people! Actually, there is a lot of truth to that statement. The earliest that a non-disabled person can enroll in Medicare is age 65. If you enroll in Medicare within six months of turning 65, Smith says, your Medicare [Part A in this case] will start on the first of the month in which you turn 65. If you enroll in Medicare after turning 65, you are entitled to as many as six months of retroactive benefits, but in no case can your effective date be earlier than when you turned 65.

Historically, people were better off with these retroactive benefit dates. Clearly, that may not be the case when it messes with their HSA program. I empathize with people who are confused, angry, or both about these rules.

Also, keep in mind that people who claim Social Security benefits before they turn 65 are too young to qualify for Part A. So, claiming Social Security doesn’t always mess with your HSA – only if you’re 65 or older.

If I know I am going to become ineligible for HSA contributions during a calendar year, can I “front load” that year’s allowable contributions before I become ineligible?

Nice try, but you can’t. “It’s important to remember that contributions to an HSA are really calculated monthly,” Smith says. For example, if someone with family coverage had $6,900 contributed to his or her HSA, the rules “credit” one-twelfth of that amount each month, or $575.

Normally, it wouldn’t 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, say, then 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 your HSA and treated as taxable income on your annual tax return. These rules are explained, albeit not always clearly, in IRS Publication 969. There are some taxpayer examples there that may be useful.

What happens to my employer’s contributions?

Let’s go back to the example where only six month’s of an employee’s $6,900 can be placed in the HSA. Let’s further say that this person’s employer has made a commitment to contribute, say, $1,500 during the year to the employee’s HSA. According to Smith, it is legal and, in his view, even ethically appropriate for the employee to permit the employer’s full annual contribution. In this example, the employee would contribute only $1,950 during the year, which is the maximum of $3,450 for six months, minus the employer’s $1,500 contribution.

“It is the responsibility of the employee to make sure there are no excess contributions [to the HSA],” Smith says. “If there are, it’s the responsibility of the employee to take care of it” before they file 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 its contribution should stop of change.”

What if I have family coverage and only one of us becomes ineligible?

Ah, now the HSA plot becomes more interesting! If one spouse becomes ineligible, the full amount of that year’s family HSA contributions normally still can be made by the eligible spouse. “The $6,900 can be contributed in any way the couple likes,” Smith says. If the ineligible spouse was making a $1,000 catch-up contribution, this will no longer be allowed.

One important requirement here is that if the employee is the person who gets Medicare and becomes ineligible, the spouse must have set up an HSA of their own to make the couple’s allowable contributions.

I thought there was a family HSA for people with family health coverage?

Nope. “There is no such thing as a joint HSA,” Smith explains. 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. Smith says 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 my employer offers only the high-deductible plan, what do I do if I am ineligible for an HSA?

If you want employer health insurance, you will need to accept the likelihood that your out-of-pocket expenses could be substantial if you can’t offset your spending with HSA funds.

People tripped up by getting Part A of Medicare should take a close look at whether it makes sense for them to reject their employer’s health plan and, instead, purchase Part B and other Medicare coverage, including a Part D drug plan and either a Medicare Advantage Plan or a Medigap supplemental plan. Most Medicare Advantage plans come bundled with a Part D plan.

If I find out I’m ineligible, how does this affect my taxes?

If you have made excess contributions and can withdraw them by the time your taxes are due, there will not be a penalty due to the IRS, Smith says. Otherwise, the penalty is 6 percent.

Will my employer report my ineligibility to the IRS?

No, Smith says. That’s up to you. And here is a reality that might surprise you. HSAs “are tax vehicles,” Smith says, and reporting them to the IRS is mostly “on the honor system.” This is also true for any HSA-related penalty payments. If you don’t report them, the IRS will only know about a problem if it audits you. The odds of such an audit are very small, but if it does occur, you face getting hit with penalties and payment of what would be considered back taxes.

What tax forms should I use for these things?

Form 8889 is used for reporting your annual HSA activity. Form 5329 is used to report excess contributions. If you use a tax preparer, you should work with them on how to file these forms, including whether you need to amend any past-year tax returns that were filed before you learned that some of your HSA contributions in a past year were illegal.