There’s an increasing dilemma for clients who choose to work even after they’ve reached retirement age, particularly after age 65. The issue is that these clients can no longer make tax-deductible contributions to their Health Savings Accounts (HSA) for six months before enrolling in Medicare. This is a common issue for clients who first become eligible for Medicare.
That six-month window may not be much of a bother for some clients, but for those with ailments or financial challenges, this can be a source of worry and concern. If you have any clients in this situation and are turning 65, it’s important to warn them that they can no longer maintain an HSA once they qualify for Medicare. In short, they can’t have both HSA and Medicare.
This situation will surely raise questions like:
In this article, InvestmentNews discusses the implications of HSA and Medicare eligibility in more detail.
Health Savings Accounts or HSAs are a form of personal savings accounts your client can open to pay some of their health care costs.
Your client can put money into it and then make withdrawals tax-free for as long as the money is used to pay for qualified medical expenses including coinsurance and copayments. Qualified medical expenses can include:
To be eligible for an HSA, your client must be enrolled in an HSA-qualified health plan. They cannot be covered by another health plan (such as Medicare or Tricare) or be a dependent on another person’s tax return.
Eligible individuals can contribute to an HSA. If it’s an employee’s HSA, the employee who owns the HSA, their employer, or both can contribute to the account.
For HSAs set up by a self-employed (or unemployed) individual, that individual can contribute.
Family members or any other person may also make contributions on the eligible HSA account owner’s behalf.
Contributions to an HSA can only be in cash; making HSA contributions in the form of other assets like shares of stock or property is not allowed.
According to some advisors, HSAs probably don’t get as much appreciation as they should. When harnessed correctly, HSAs offer investors some unique benefits. For instance, there are at least three ways that an HSA can help your client save money:
The Latest Health Care News From Investment News - HSA balances continue to grow along with usage.https://t.co/nw3ALErL7Q#EBRI #healthcare #insurance #hsa #healthsavingsaccount #jakespiegel #investmentnews #savings #news @investmentnews
— Employee Benefit Research Institute (@EBRI) March 14, 2024
Your client decides how much to contribute to their HSA, how to invest, and how to use the funds.
They can add money to their HSA by:
Your client can also choose to make contributions to their HSA by making a one-time payment, or making several payments over time until the account is fully funded.
It’s the IRS that determines the contribution limits to an HSA. In 2024, the amounts that can be contributed to an HSA are:
The 2024 contribution limits are approximately 7% higher than the HSA contribution limits for 2023.
If your client reached the age of 55 or older as of December 31, 2018, they can also make a $1,000 extra catch-up contribution.
In May 2024, the IRS announced the 2025 HSA limits:
Typically, your client’s employer may oversee their HSA, or they may have an individual HSA managed by a bank, credit union, or insurance company.
Medicare is the U.S. federal health care program for citizens who are aged 65 years or older. The program is also meant to look after the needs of people with certain disabilities.
Although Medicare can be used to pay for hospital stays, medical services, and some prescription drugs, people who are on the program must pay a portion of their health care costs.
The different parts of Medicare
Medicare has four different key components: Medicare Parts A, B, C, and D. They are categorized according to the medical expenses they cover. Here’s how they differ:
The combination of Parts C and D that’s used to pay for a prescription drug plan is called the Medicare Advantage prescription drug (MAPD) plan.
This is the most crucial item for your clients to remember when they finally enroll in Medicare:
Anyone who qualifies and then enrolls in any part of Medicare can no longer contribute to their HSAs. These are rules set by the Internal Revenue Service.
If your client chooses to work past their retirement age of 65 and would like to keep contributing to their HSA, check if they can delay their Medicare enrollment. If your client has begun to receive Social Security Benefits, they will have to enroll in Medicare Part A.
Savvy financial planners are very much aware that HSAs and Medicare typically don’t play well. However, there are ways to leverage them both, as this video explains.
If your client has to enroll in Medicare because they must take on Social Security benefits, Medicare coverage is retroactive to a maximum of 6 months. This means that your client must stop contributing to their HSA for at least 6 months as well before they get Social Security or enroll in Medicare. They should determine the exact date and stop contributions by then to avoid any penalties for excess contributions.
While this may sound disappointing, tell your clients not to fret. Although they can no longer contribute to their HSA, your clients can still use the HSA to pay for qualified medical expenses. When paying for qualified medical expenses, the withdrawals are tax-free.
This is probably the only area where HSA and Medicare overlap – the HSA can cover:
The easy answer is no. Once your client is taking Medicare Part A and/or Medicare Part B, they are no longer allowed to set up a new HSA or contribute their pre-tax dollars to an existing HSA.
Generally, contributing pre-tax dollars to an HSA means an individual cannot have any health insurance other than a High Deductible Health Plan or HDHP.
Your client can take distributions or withdrawals from available funds in the HSA at any time.
Ideally, these should be for paying qualified medical expenses. This is why it’s important that your client completes funding their HSA before the six-month retroactive period for Medicare kicks in.
HSA distributions or withdrawals can be of two types:
These are used to pay for an eligible medical expense either by:
These are distributions or withdrawals spent on other purposes, not for paying eligible medical expenses. This is taxed as ordinary income and, if the HSA owner is not 65 years old yet when they made the withdrawal, it gets an additional 20% penalty.
Should your client be unable to fully fund their HSA before their target date ahead of Medicare enrollment, the HSA owner can no longer make contributions, but they can access the funds. Fortunately, HSAs do not have a “use it or lose it” clause – HSA owners can leave the money untouched for future use.
One of the main reasons why HSAs are popular savings vehicles for retirement is that the money contributed to it is not taxed. Withdrawals and distributions from an HSA are also tax-free, provided the funds are used for IRS-approved, eligible expenses.
Only when money is taken out of an HSA to pay for non-medical expenses are the funds subject to a 20% penalty along with the appropriate tax penalties. However, if the HSA owner is age 65 or older, they can withdraw funds for any reason and not incur penalties; the only catch is they will have to pay the appropriate taxes for non-medical expenses.
Here’s how HSA and Medicare are taxed:
HSA Item | Taxes | Penalties |
Payment for qualified medical expenses | None | N/A |
Other non-medical expenses | Appropriate income tax | 20% of the withdrawn amount |
Withdrawals at age 65 or older | None, or appropriate income tax if not for medical expenses | None |
Contributions to HSA | None | N/A |
Medicare pays some taxes, depending on which parts of Medicare an individual worker uses.
Clients who want to delay Medicare enrollment because they are still working and want to continue contributing to their HSA may also consider delaying their Social Security retirement benefits.
Anyone who collects Social Security benefits when they become eligible for Medicare is automatically enrolled into Medicare Part A, and this simply cannot be refused. If your client insists on growing their HSA to pay for medical expenses, then delaying Social Security benefits (despite the fear of it running out) and Medicare is the logical move.
Clearly, deciding on when to stop making contributions to an HSA and signing up for Medicare or Social Security (which triggers Medicare Part A) involves crucial timing. As a financial advisor, you can guide your clients in mapping out their financial goals and medical needs, if necessary. Help them schedule their HSA exit well to enjoy the benefits of Medicare. That way, when it comes to HSA and Medicare, your clients get the best of both worlds.
Help your clients balance their HSA and Medicare benefits – read and bookmark our Retirement page for more retirement planning strategies.
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