Beware of a six-month look-back period and tax penalties

By Mary Beth Franklin

Many clients have chosen to enroll in health savings accounts (HSAs) because they like the triple tax savings that HSAs offer when paired with a high-deductible health insurance plan. But things can get very complicated when clients approach Medicare-eligibility age. The rules are complex and the penalties are steep.

HSAs offer a triple tax-break. Contributions are tax-deductible. Assets grow tax-free. And distributions are tax-free if used for qualified medical expenses. Non-qualified distributions are subject to ordinary income taxes and a 20% penalty if withdrawn before age 65. Once you turn 65, you can use HSA funds for any purpose penalty-free, but if distributions are used for non-medical expenses, they are subject to income tax.

Because health care expenses often represent a significant portion of a retiree’s budget, there is no shortage of ways to spend HSA dollars tax-free in retirement. Most medical and dental procedures count as qualified medical expenses, as do vision care, prescription drugs, long-term care insurance premiums and Medicare premiums. However, you cannot use HSA funds tax-free to pay for supplemental Medigap insurance premiums or over-the-counter drugs.

Many individuals are surprised to learn they are no longer able to contribute to an HSA once they enroll in Medicare. If you are collecting Social Security when you are 65, you will be automatically enrolled in Medicare. When that happens, you and your employer must stop contributing to your HSA. If you contribute to your HSA after your Medicare coverage starts, you may have to pay a tax penalty.

Medicare Part A, which covers hospitalization, is free. Medicare Part B, which covers outpatient services, carries a monthly premium. If you or your spouse continue to work beyond age 65 and have employer-provided health-insurance coverage, you can delay enrolling in Medicare Part B penalty-free until the employer-provided health insurance ends.

But here’s a detail that may surprise many advisers and their clients: Once you are older than 65 and apply for Social Security benefits, you must enroll in Medicare Part A. It is mandatory. And once you enroll in Medicare, you can no longer contribute to an HSA.

The timing of your Medicare enrollment and its impact on HSA contributions is tricky.

If you enroll in Medicare at 65, you lose eligibility to contribute to an HSA on the first day of the month you turn 65. For example, if you turn 65 on July 21, you are no longer eligible to contribute to an HSA as of July 1 (but you can continue to spend HSA funds on qualified expenses tax-free). “Your maximum contribution for that year would be 6/12 times the applicable federal contribution limit,” according to

For 2017, an individual can contribute up to $3,400 to an individual HSA or $6,750 for a family HSA. Eligible individuals who are 55 or older (but younger than 65) can contribute an additional $1,000 in 2017. So a worker who turns 65 on July 21, 2017, could contribute $3,875 for the year which includes half of the allowable amount for a family HSA plus half of the maximum $1,000 in catch-up contribution.

If you enroll in Medicare after age 65, the impact on HSA contributions is more complicated. When you sign up for Medicare you will be enrolled retroactively for up to six months of benefits, or back to your 65th birthday if that has taken place within the last six months. “To avoid a tax penalty, you should stop contributing to your HSA at least six months before you apply for Medicare,”, the official government website, recommends.

There may be a way around the six-month look back period, said Jon Smith, vice president of wealth planning at Stifel, Nicolas & Company in St. Louis.

“If it is not your desire to receive retroactive Medicare benefits so that you may maximize your HSA contributions, you must be very specific in instructing the enrollment representative at the Social Security Administration that you do not want to be enrolled for any retroactive benefits,” said Mr. Smith, who has written extensively on the value of health savings accounts and the potential pitfalls for retirees.

“This may require a phone appointment, or a trip to your local Social Security office so that you may be certain your wishes are carried out,” he added. “The last thing you want to happen is to enroll online, receive retroactive benefits and spend the next portion of your life trying to unwind the unexpected mess you have found yourself in.”

So what’s an older worker to do? recommends a more conservative approach. “If you would like to continue contributing to your HSA, you shouldn’t apply for Medicare, Social Security or Railroad Retirement Board benefits.