Changes to Medicare Part D Drug Benefit Will Be Felt by HSA Owners

Health Savings Accounts and Medicare have always had an uncomfortable relationship. New changes coming to the Medicare prescription-drug benefit will complicate planning.

Health Savings Account contributions and Medicare enrollment are mutually exclusive. A senior who is enrolled in any Part of Medicare can't contribute to a Health Savings Account, and an account owner who wants to continue to fund her account can't be enrolled in Medicare.

That part is simple. What complicates the picture is the effect of an individual's prescription-drug coverage between her 65th birthday and the month that she's first covered by Medicare Part D. The value of prescription coverage during that span affects a future Part D enrollee's lifetime Part D premium.

Let's visit this issue and examine how a change in the Medicare Part D prescription-drug program effective in 2025 may alter the equation for some seniors who haven't yet enrolled in Part D coverage.

Medicare Creditable Coverage

If you enroll in Medicare when you're first eligible around your 65th birthday, you can sign up with no penalty, regardless of your coverage before that milestone birthday. If you defer Medicare enrollment at age 65 - usually because you're covered by your own or your spouse's employers' plan - you face potential penalties for late enrollment.

The Part D penalty

Whether you pay a penalty when you delay enrollment in Part D depends on the quality of your prescription-drug coverage from the month of your 65th birthday until you finally enroll. If your coverage prior to enrolling in Part D is at least as rich as Part D (a concept referred to as Medicare Creditable Coverage, or MCC), you won't pay a penalty - ever. On the other hand, if your coverage for any month after your 65th birthday isn't as rich as Medicare, you face a lifetime premium surcharge.

The penalty is equal to 1% of the Part D national base beneficiary premium for each month that coverage. The national base beneficiary premium is about $35 in 2024 (the average total premium is about $55, but that figure isn't relevant to the penalty).

Example: You delay enrolling in Medicare until the month of your 67th birthday. Your commercial coverage wasn't MCC. Those 24 months of non-MCC coverage translate to a 24% lifetime monthly premium surcharge, or about $8.40. If your premium is $55, you pay $63.40 monthly in 2024 with the surcharge. As the national base beneficiary premium rises in future years, so does the effect of a surcharge calculated as a percentage of that figure.

There is no way to fix a month of non-MCC retroactively. Once you've accumulated such a month, you carry its effects with you for the rest of your life.

The HSA-qualified Plan Problem

Because most or all prescription drugs are applied to a combined medical/Rx deductible on an HSA-qualified plan (some plans cover certain preventive prescriptions below the deductible, usually subject to a copay, which increases the likelihood that a plan meets MCC), many of these plans fail to meet MCC standards. Thus, HSA-qualified plan enrollees are more likely than their contemporaries enrolled on other coverage to have the penalty applied to their future Part D premiums.

In contrast, a plan that covers prescription drugs subject to copays or a combination of copays and coinsurance is far more likely to meet the MCC standard.

The 2025 Part D Challenges and MCC

The Part D prescription-drug program will undergo a fundamental change effective Jan. 1, 2025. Since its inception in 2006, the benefit has included a "donut hole," during which enrollees were responsible for 100% of the allowable expense of the drug. That reimbursement gap will be eliminated in 2025, reducing enrollees' out-of-pocket costs. This change will affect Health Savings Accounts in two ways.

Fewer plans will meet MCC. Although the changes reduce retirees' out-of-pocket prescription-drug expenses, they also raise the bar on commercial plans to become MCC. Reducing patient responsibility will increase the actuarial value of the Part D plan, thereby rendering more commercial plans non-MCC. As a result, more future Part D enrollees will be subject to penalties in the form of permanent monthly premium surcharges.

Premiums will rise. Filling the donut hole isn't a gift. It comes with a cost. Perhaps the federal government's dictating the prices of the 10 most costly prescriptions will bring overall costs down a little. But filling the donut hole with insurance reimbursement will raise both the premiums and the national base beneficiary premium (the figure to which the percentage surcharge is applied).

Example: Adelbert, age 67, planned to remain covered on his wife's company's HSA-qualified plan and continue to make his annual catch-up contribution to his Health Savings Account (and his wife continue to fund her account at the statutory family, rather than the self-only, ceiling) until he enrolls in Medicare at age 70. Her plan met MCC requirements when he was age 65 and 66. In 2025, the same design is no longer MCC because of the changes to the Part D program. Let's say the national base beneficiary premium rises to $48 (this is just an example - I have no inside information) due to the 2025 changes. If Adelbert follows his plan, he'll have three subsequent years of non-MCC coverage. He'll pay a 36% penalty on a national base beneficiary premium of $55 (again, this figure is for illustrative purposes only) the year that he turns age 70. Thus, instead of no lifetime monthly surcharge, he'll pay an additional premium of about $20 per month in the year that he turns age 70. That amount will rise as the 36% penalty is applied to a higher base in future years.

To avoid this situation, Adelbert can forego his catch-up contributions after age 67, enroll in Medicare then, and avoid penalties. He'll pay a Part B and Part D premium. HIs wife can continue to cover him on her company's medical plan so that she has family coverage and can contribute to the statutory limit for a family plan ($8,300 in 2024, rising to $8,550 in 2025).

The MCC standard ignores the trade-offs that many Health Savings Account owners make voluntarily: to accept higher out-of-pocket costs in exchange for a lower premium. The new program forces all Part D enrollees into a one-size-fits-all benefit that reduces patients' financial responsibility and covers this change by charging higher premiums.

The good news is that the new MCC standard won't be applied retroactively. A senior age 66 or older today who satisfied the MCC requirement in 2023, for example, won't lose that status because of a change that's effective in 2025. But someone who had planned to have an MCC prescription-drug plan to age 70 and thus avoid any monthly premium surcharge may take an unexpected hit without a course correction. That unexpected surcharge will be applied to a higher national base beneficiary premium for the rest of her life.

In sum, a double whammy.

The Saving Grace

The good news is that Health Savings Account owners can reimburse these higher Part D premiums tax-free from their accounts. Because these higher withdrawals are not included in taxable income, they will offer the same benefit as other distributions for qualified expenses:

• They won't affect taxation of Social Security benefits, which increases with higher incomes, as withdrawals from tax-deferred retirement accounts do.
• They won't affect Medicare Part B premiums, which are subject to premium surcharges at higher levels, as distributions from tax-deferred retirement accounts do.

But these tax benefits are offset by the fact that owners will have to withdraw more money monthly from their Health Savings Account to pay their Part D premiums.

The Bottom Line

The new Part D design will help some enrollees (high prescription utilizer, for whom savings from eliminating the donut hole will more than cover higher premiums) and hurt others (enrollees with few prescriptions who'll also pay the higher premiums required to reduce cost sharing. In fact, many enrollees will feel both effects - paying more in premiums without an offsetting cost-sharing reduction early in retirement, then benefitting when savings from filling in the donut hole more than offset the premium increases.

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HSA Wednesday Wisdom is published every other week, alternating with HSA Question of the Week. The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.