Sorting through the Medicare Part A Six-Month Retro Rule and HSAs

When you enroll in Medicare, your coverage may be retroactive. That may or may not affect your Health Savings Account contribution limits during your final year of eligibility.

Late last week, a colleague in my Health Savings Account world forwarded me as series of questions from a friend of his who was trying to figure out the interplay of Health Savings Account contributions, Social Security enrollment, and Medicare retroactive coverage. To many people, these are three entirely separate issues - a financial account, a retirement benefit, and medical coverage. But my colleague's friend knew enough to know that they can form a financially toxic interaction. He just needed to understand exactly how.

Let's review the issues and create a strategy.

Social Security and Medicare

Social Security is a federal program designed to supplement retirement income. (Its benefits extend to certain other people, but our focus is on the old-age portion of the program.) People become eligible to enroll at age 62 with reduced benefits (which more than half of all enrollees choose). You're eligible for full (higher) benefits at some point between your 66th and 67th birthdays (depending on your year of birth) and for additional (highest) monthly checks if you wait until age 70 to collect.

Medicare is a federal program that provides medical coverage to the elderly (again, some other groups are entitled to benefits, but our focus is on this aspect). There is no early-enrollment option or richer benefits if you delay enrollment. You're entitled to enroll at age 65 and can enroll at that time or at any point in the future. You may pay a penalty (in the form of lifetime higher premiums) if you don't enroll when you're first eligible. Or you may not. That's beyond the range of this discussion.

Most people receive Medicare Part A, which covers inpatient care, hospice, and home health care, at no cost because they prepay premiums through payroll taxes during their working years. If not, they must pay a monthly premium to enroll and remain covered. Premiums apply to Part B (outpatient services) and Part D (prescription-drug coverage).

The Interplay of Social Security and Medicare

If you're age 65 or older and collecting Social Security benefits, you're automatically enrolled in Medicare Part A (unless you must pay a premium for Part A, which is rare). That's true even if you're still working, are happy with coverage on your employer's plan, and won't receive any additional benefits from enrolling in Part A. Part A coverage is automatic and mandatory if you're collecting Social Security benefits. Period.

The Social Security/Medicare/HSA Collision

You can make or receive contributions to a Health Savings Account if you're enrolled in an HSA-qualified plan, don't have disqualifying coverage, and aren't another taxpayer's tax dependent. In 2021, you can contribute up to $3,600 ($3,550 for 2020) if you're covered on a self-only plan and up to $7,200 ($7,100 for 2020) if you have a family plan. If you're age 55 or older, you can deposit up to an additional $1,000 annually.

Here's the problem when Social Security, Medicare, and Health Savings Accounts collide: Medicare is disqualifying coverage that prohibits you from funding a Health Savings Account.

Example: You're age 67 and working full-time. You're covered on your company's HSA-qualified plan. Your employer deposits $2,000 annually into your account, and you contribute additional funds to reduce your taxable income and cover your medical, dental, and vision expenses. You choose to begin collecting Social Security at age 67 in January 2021 because your benefit won't be reduced by your wages.

In this scenario, here's what happens:

• Your enrollment in Social Security is successful.
• You're automatically enrolled in Medicare Part A, which you receive with no premium. If your company has 20 or more employees, Medicare is secondary coverage. This means that providers submit your eligible claims to your company's insurer first, then to Medicare. Medicare may pay a portion of the bill.
• Your Medicare Part A enrollment is retroactive, meaning that your coverage is extended back six months from the actual effective date. This retroactive enrollment may result in your receiving a small benefit from Part A prior to what you thought was your effective date.
• Medicare is disqualifying coverage, which means that you can no longer contribute to your Health Savings Account or accept the company's contribution.
• Because your Medicare enrollment is backdated six months, you weren't eligible to make or receive contributions to your Health Savings Account for any month after June 2020. But you did contribute. And so did your employer.

Avoiding the Collision

If you understand the rules, you can avoid the collision in one of two ways.

First, enroll in Medicare at age 65. That way, there is no retroactive coverage. You'll be disqualified from contributing to your Health Savings Account for any month after your Medicare Part A enrollment is effective. If your 65th birthday is Oct. 6, 2021, you can contribute up to 9/12 of $3,600 (a total of $2,700) or $72,00 ($5,400), plus 9/12 of $1,000 ($750). That's easy.

But what if you want to continue working and funding your Health Savings Account? Have at it! As you plan your Social Security and Medicare enrollments, be sure to stop contributing to your Health Savings Account beginning six months before you enroll in Medicare. That way, you don't have to withdraw any contributions based on retroactive Part A coverage.

In either case, be sure to notify your company's benefits department when you're no longer eligible to fund your account, since the door closes on employer contributions as well. If you remain covered on the company's HSA-qualified plan, your employer may not know that no longer HSA-eligible (even if you stop your pre-tax payroll deductions).

Cleaning up after the Collision

But often the best laid plans go awry, and you may not know in advance when you'll enroll in Part A. There are many factors - like the state of the economy or your employer, or your own or a family members' health - that may accelerate your Part A enrollment.

If you do enroll earlier than you anticipated, you may have overcontributed to your account. If so, you need to resolve this problem. Fortunately, the correction isn't difficult. If you end up retroactively enrolled in Medicare effective April 1, 2021, for example, your maximum 2021 contribution, based on your contract type, is $900 or $1,800, plus a $250 catch-up contribution (each of these figures is 25% of the $3,600, $7,200, and $1,000 contribution ceilings for 2021). If you or your employer have contributed more, you need to work with your Health Savings Account administrator to remove any deposits above that amount (plus any interest or investment gains on the excess contributions) before you file your 2021 personal income tax return.

You need to notify your employer to cease company contributions as well. But you don't have to return any money to your company. If, for example, your employer seeded your account with $1,200 at the beginning of the year, you don't need to return $900 (75%) in our example to the company. You must withdraw any amount above your pro-rated contribution limit - regardless of source - from your account.

The Final Word

Don't let your Health Savings Account contributions and the resulting tax benefits drive your decision about when to begin to collect Social Security benefits. The average monthly Social Security benefit in 2021 is about $1,543. The average tax savings on an $8,200 annual contribution to a Health Savings Account is about $200 monthly.

But be sure that you understand the implications of enrolling in Social Security and retroactive enrollment (if it applies) in Medicare Part A so that you don't overfund your Health Savings Account. You can adjust your contributions prospectively or correct excess contributions after the fact to bring yourself in compliance with Health Savings Account rules.

I'm director of strategy and compliance at Benefit Strategies, LLC, a provider of Health Savings Accounts and other tax-advantaged benefits. You can read my biweekly Health Savings Account GPS blog and subscribe by clicking here and my weekly HSA Monday Mythbuster and HSA Wednesday Wisdom columns, as well as my occasional Healthcare Update column, on LinkedIn. My book, HSAs: The Tax-Perfect Retirement Account, is the definitive guide to navigating the intersection of Health Savings Accounts, Medicare, and retirement planning. It's available in book and e-book forms from Amazon.

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