Why employed Americans with an HSA need to pay attention to Medicare and Social Security enrollment

The crux of this problem lies with the rules governing HSA contributions and the regulations on Medicare enrollment not playing well with each other. 

HSAs allow both employees and employers to make tax-free contributions to an account that can be used to pay certain medical expenses. But an employee (or employer on behalf of the employee) can only contribute to these accounts if the employee's health insurance plan qualifies as a high deductible health plan (HDHP). For 2022, that means the deductible must be at least $1,400 for an individual or $2,800 for a family. 

Medicare, which most Americans can enroll in starting at age 65, does not meet this definition, and therefore is deemed disqualifying coverage, thereby barring participants from continuing to make HSA contributions. The bottom line is that once a person is covered by Medicare, they need to stop contributing to their HSA or risk paying penalties to the IRS. But when exactly this coverage begins is not always clear.

The penalty is 6% of the excess each year until the person rectifies the excess contribution problem, if someone were to make a contribution in excess of their allowable limit. To rectify the issue, individuals need to remove the amount of the excess and any related earnings (if there were any) for that taxable year by the tax filing deadline.

The 3 Es of Medicare coverage

The confusion surrounding Medicare coverage timing is likely due to the difference in being eligible, enrolled and entitled to Medicare. These words have very different connotations and potential ramifications to a person's ability to make HSA contributions.

• Being "eligible" for Medicare means that a person can enroll in coverage, generally because of turning 65 or, if a person is under 65, disabled and receiving Social Security benefits.
• "Enrolling" in Medicare is the process under which the person would select coverage, which for most people can begin 3 months before they turn age 65.
• And finally, being "entitled" for Medicare means you have already enrolled, and are actually covered, which means you can have claims paid on your behalf by Medicare.  

Additionally, when you enroll and when you are entitled to coverage do not necessarily align either. For example, if you enroll in Medicare when you first become eligible 3 months before you turn 65, your coverage actually begins the month you turn 65. There are many different scenarios that can impact the date that coverage begins so people who wish to contribute up until this point need to pay attention to when their Medicare coverage begins and stop contributing as soon as this occurs.

Working seniors

More and more Americans are working past age 65, and many of these people wish to continue making HSA contributions. The solution for workers eligible for Medicare but who still want to contribute to their HSA seems simple — do not apply for Medicare coverage and stick with the HDHP provided by the employer. However, another common scenario may cause an issue for these people if they elect to begin receiving Social Security retirement benefits, because enrollment in Medicare Part A coverage is automatic when enrolling in these payments. Regardless of how Medicare enrollment would occur (either willingly or automatic), once that coverage begins, the person is no longer able to continue their HSA contributions.

Retroactive Medicare coverage  

Likely the least understood issue that can arise for new Medicare enrollees are scenarios when Medicare coverage becomes retroactive. This is especially important to those who elect to delay Medicare or Social Security benefits to postpone HSA ineligibility.

In these circumstances, it is important to note that Medicare Part A coverage is retroactively effective 6 months for individuals who delay Medicare (or Social Security) benefits. So, if a person does not enroll in Medicare when they are first eligible (and, also are not enrolled in Social Security), his or her later enrollment in Medicare Part A causes their coverage to be effective retroactively for 6 months.

Therefore, if a person declines Social Security retirement benefits and Medicare coverage in order to contribute to the HSA, once they do enroll in Medicare, their coverage for Medicare Part A is effective for the preceding 6 months, making them HSA ineligible for those 6 months. Any contributions to their HSA for those 6 months would now be considered in violation of the IRS rules and be subject to an overcontribution penalty.

As long as employees who have deferred signing up for Medicare stop making contributions to their HSA (and inform their employers to do the same) at least 6 months prior to applying to Medicare, employees will not be in violation unless they apply for Social Security benefits. If they apply to receive Social Security payments, they will automatically enroll in Medicare as soon as they become eligible. Employees who elected to receive Social Security benefits before they aged into Medicare eligibility should stop contributing to their HSA before they become eligible so there is no risk of overlap. 

This practice of applying retroactive Medicare coverage began in 1983, long before HSAs came into existence. This really is an unintended circumstance but one that needs attention to avoid penalties for people in these scenarios.  

How employers can help

Barring any drastic changes from the IRS or other government agencies, this hitch in the system will continue to pose a financial risk to employees who are nearing or who have turned 65 who contribute to an HSA.

There may be changes to this practice in the future as The Centers for Medicare & Medicaid Services (CMS) has proposed draft regulation to change retroactive coverage from mandatory to voluntary to align better with Social Security retirement benefits; however, this is not currently in place.

With the HDHP and HSA pairing becoming increasingly popular with employers, HR teams should re-double their efforts to provide clear and concise communication about when employees should stop contributing to their HSA—education and awareness can go a long way toward avoiding unexpected fees and taxes.

For more information on tax penalties, refer to the Medicare & You 2022 Guide or consult your tax advisor.

Kevin Robertson is Chief Revenue Officer at HSA Bank.