Americans are retiring later than ever. At the same time, they are facing increasing healthcare expenses that will take up a larger portion of their budget when they do retire. Consider that the current out-of-pocket cost of healthcare for a Medicare-covered retiree is $5,000 to $6,000 per year even after taking into account the services covered by Medicare.1 Planning and saving for these costs are fundamental considerations to ensure financial wellness in retirement, and so employees need to understand the full picture of how their health savings accounts (HSAs) interact with Social Security and Medicare.
HSAs are growing in popularity as a way to save for healthcare expenses in retirement due to their multiple advantages. The HSA’s triple tax benefit means contributions to the account are made on a pre-tax basis, lowering taxable income. Interest and earnings on HSA funds are tax-free, and funds withdrawn to pay for qualified medical expenses are tax-free. Another benefit is that the funds in an HSA belong to the individual, not the employer, and roll over each year without restriction and regardless of employment.
Individuals may make HSA contributions if they are enrolled in a qualified high-deductible health plan (HDHP) and have no other “disqualifying health coverage.”
Enrollment in any part of Medicare is considered disqualifying coverage. While this rule sounds straightforward, employees who delay retirement beyond age 65, and are therefore eligible for Medicare, might unknowingly run afoul of it.
Here are some scenarios that illustrate the interplay of HSA contributions, Social Security retirement benefits and Medicare:
An employee over age 65 who has not started receiving Social Security retirement benefits may delay Medicare enrollment and continue making HSA contributions. When the employee enrolls in Social Security, however, the employee’s Medicare benefits are deemed to have begun six months prior (but not before the employee’s 65th birthday). The impact of this backdating is that the employee is retroactively ineligible to make HSA contributions for up to six months prior to enrolling in Social Security/Medicare. And, in the year he or she enrolls (or is deemed to have enrolled) in Medicare, the employee’s HSA contributions may not exceed a prorated amount of the IRS annual contribution limit.
Due to the way Medicare and Social Security retirement benefits can impact HSA eligibility, employees nearing or over age 65 should plan ahead to avoid overcontributing to their HSAs. If an employee overcontributes to his or her HSA because of being enrolled (or deemed to be enrolled) in Medicare, the employee should withdraw the excess contributions before the tax filing deadline (including extensions) to avoid repercussions. Otherwise, the employee will owe back taxes on previously excluded income and a 6% excise tax on excess contributions.
Finally, while individuals cannot contribute to an HSA if they are enrolled in Medicare, they may use existing money in an HSA to pay premiums for Medicare Parts B, C and D (but not for Medicare Supplement or Medigap plans). They may also use this money to pay for qualified out-of-pocket medical, dental and vision care expenses.
Employees have a lot to think about as they approach retirement age. As part of a robust benefit offering, helping them understand the rules concerning HSAs, Social Security and Medicare will go a long way toward easing the transition and enhancing their overall financial security.
1 Financing health care in retirement — The role of the health savings account, WTW 2020
