Coordinating HSA Contributions with the Commencement of Social Security Benefits; Beware of Unintended Consequences

High deductible health insurance plans with the resulting availability of a sizeable, above-the-line, income tax deduction for contributions to a Health Savings Account (HSA) have become an attractive option for insureds, some of whom continue group employer health insurance even though eligible for Medicare.

The high deductible plan lowers the insurance premium for the employer and these savings are typically passed, to some extent, through to employees who contribute to the cost of their health insurance.Thus, employees can save on their contribution for health insurance coverage by participating in a high deductible plan plus make significant tax deductible contributions to a HSA.[1]

From a health care cost policy point of view, such an arrangement should make the insureds wiser consumers of medical care as funds accumulate in their HSA accounts.

To be eligible for the high deductible plan and the HSA income tax deduction, however, the insured may not be covered by any other health insurance plan or other reimbursement arrangement.

There is an important and unexpected fly in the ointment, however, when an HSA participant (or the participant’s spouse) applies for Social Security benefits after the participant’s age 65 Medicare eligibility date. This is so because on the back of Social Security benefits comes an unexpected guest: Medicare A coverage.

Medical insurance for retirees includes an unpardonably complex and Byzantine set of rules and options. Suffice it to say that an employee (or employee’s spouse) could continue under an employer’s group health plan and receive both Social Security and Medicare benefits.

Medicare A benefits (basically, hospital coverage) are paid for by payroll deductions during employment, while Medicare B benefits (basically, coverage for everything else except drugs) are paid by a monthly premium, typically deducted from Social Security benefits. If the employee continues under the employer health plan while receiving Medicare A coverage, typically the employee will opt out of Medicare B coverage and pay no Medicare B premiums.

To make matters worse with respect to eligibility, Medicare A coverage is not optional and cannot be refused even if the benefit is not wanted. Moreover, Medicare A coverage is retroactive for six months from the date the employee called Social Security to elect to commence Social Security.

Thus, the Medicare-eligible employee who receives Social Security benefits while participating in the HSA plan has unwittingly become covered by Medicare A (likely to be a totally worthless benefit unless the employee happens to be hospitalized) and now is ineligible for the HSA income tax deduction, starting with the retroactive commencement of the Medicare A coverage. Participating in the HSA plan prior to the commencement of Medicare A coverage is permitted, but the income tax deduction is prorated for the year in which participation began and excludes the part of the year when Medicare A coverage is effective.

If not an irremediable disaster, the situation is at least aggravating and complex. HSA contributions, if already made, must be withdrawn or be subject to penalties.[2] If not yet made, contributions may only be made for the portion of the year when there is no Medicare A coverage. Ineligibility to participate in the HSA going forward has no negative effect on HSA accumulations to the date of ineligibility. HSA funds are still available to pay uninsured medical expenses, but no additional contributions may be made.

As with many retirement issues, thoughtful planning beforehand is the answer. When the employee is given a choice between a high deductible and regular health insurance plan, it is likely to be preferable (and certainly simpler) to avoid participating in the high deductible plan in the calendar year in which Social Security and Medicare A coverage begins. Recall that participation is retroactive six months from the date that Social Security is contacted to commence retirement benefits.

Many would consider it no shame to pay the higher deductibles of a high-deductible plan and not have the option to contribute to the HSA.

The moral of the story is to coordinate the commencement of Social Security benefits (over which the employee has complete control) with the commencement of a plan year in which the employee could participate in a high deductible health insurance plan. While each situation deserves individual attention, it may be preferable not to be covered under a high-deductible (HSA) plan in the year in which Social Security benefits start and retroactive Medicare A coverage kicks in.

• John T. Bannen: (414) 277-5859 / john.bannen@quarles.com