Tag Archives: Change in Coverage

HSA Expenses Incurred Before Opening Account

Opening an HSA

The timing of opening your Health Savings Account –going to a bank and actually creating an account in your name– ends up being quite important for your finances. The reason is the date you open your Health Savings Account is the date that qualified medical expenses begin for you. Any medical care incurred before you open your HSA does not count as a qualified medical expense. Said another way, you cannot use pre-tax dollars to purchase medical care that occurred before you actually created your Health Savings Account. Per IRS Form 969:

For HSA purposes, expenses incurred before you establish your HSA aren’t qualified medical expenses. State law determines when an HSA is established.

It is actually easier than most people think to open up a Health Savings Account. The main difficulty comes in choosing a provider. Things I look for are low fees, online banking ability, phone app, and investment options. Once you find the financial institution you wish to bank with, you need to apply for the account. While this sounds painful, it is actually quite simple. To open the HSA, they will need standard information such as name and address, and also some information about your health insurance. They will use this to validate that you do in fact have an HDHP, and also use your self-only or family coverage for a rough determination of your contribution limit for the year. They use that information to help prevent contribution mistakes and it aides in generating Form 5498-SA and Form 1099-SA. Once you submit that, you are all set, and you can begin making contributions to your HSA.

The cost of not opening an HSA

You must overcome the tendency to delay opening your HSA, as it could come back to bite you. If you have HSA eligible insurance but have not yet opened a Health Savings Account you may be on borrowed time, as any medical expense incurred cannot be paid with pretax dollars. The risk to you can be equal to the (amount of expense) x (your tax rate). Even a $100 expense for someone in a 25% tax bracket will end up costing them $33 extra. Said another way, it takes $133 dollars taxed at 25% to pay for a $100 medical expense. For an HSA holder, they only need to earn $100 to pay for the expense. Multiply this expense by 10 and this $1,000 expense will cost you $333 in extra tax dollars paid, all of which is completely avoidable. This money adds up and there is no reason to pay it with the generous HSA contribution limits.

Effect on Contribution Limit

While opening the actual Health Savings Account begins the process of allowing qualified medical expenses, it does not have an effect on your contribution limit for the year. Your contribution limit is based on when you are an eligible individual. So you can have HSA eligible insurance and be allowed to contribute to your not-yet-open HSA. Of course, you will need to open that Health Savings Account before you make that year’s contribution.

Take the following scenarios as an example:

HSA coverage begins	HSA opened	QME begin	Contribution Limit	Last Month Rule?
January 1st	June 1st	June 1st	Full	N/A
January 1st	January 1st	January 1st	Full	N/A
June 1st	June 1st	June 1st	1/2 up to full	Optional
June 1st	October 1st	October 1st	1/2 up to full	Optional

As you can see above, delaying in opening your HSA can prevent you from paying for medical care from your HSA. If you plan on contributing to an HSA you might as well open the account as soon as possible, to take advantage of paying for medical care tax free with the HSA.

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Note: if you need to keep track of HSA purchases for yourself, your spouse, or your children, please consider my service TrackHSA.com for your Health Savings Account record keeping. You can store purchases, upload receipts, and record reimbursements securely online.

Deciding to Use the Last Month Rule for New HSA Coverage

This question was submitted by HSAedge reader Beth. Feel free to submit your question today to evan@hsaedge.com.

I have an employer that is implementing an HSA eligible plan on 4/1/2017. Of course, everyone wants to invoke the “last month rule” but we keep telling them that is not a best practice due to the possible tax implications should they switch plans etc. Can you give some examples of “problems” with someone enrolling 4/1/2017 invoking the last month rule and not remaining covered during the testing period?

That is certainly a good question and applies to many people who begin HSA coverage mid year. As I see it, they have two options in front of them – reduce their contribution pro rata for the months covered, or contribute the full year amount by using the Last Month Rule. The former is safe with no risk of paying taxes and penalties in the following year, while the latter allows you to contribute more in the current year.

Contribute Only for Months Covered to Lower Risk

Let’s be clear on the situation facing your team. With coverage beginning on April 1st 2017, they will have 9 months of HSA eligible coverage for 2017. Stated differently, they are covered by a HSA eligible insurance for 75% (9/12) of 2017. Since they only have partial year coverage, the amount they can safely contribute to their HSA that year is reduced pro rata. In this case, they can contribute 75% of the contribution limit based on their coverage type and age, no strings attached. For 2017, these amounts are:

Self only: $3,400 x 0.75 = $2,550
Family: $6,750 x 0.75 = $5,062.50
if 55+: $1,000 x 0.75 = $750 in addition to above

So they can contribute those amounts, free and clear, and be finished. Making contributions for the months you had HSA eligible coverage means you never have to worry about taxes or penalties relating to the Last Month Rule.

Contribute More Using Last Month Rule

However, they may be aware that there is a provision called the Last Month Rule that states that if they have HSA eligible insurance on December 1st of a year, that they can contribute the full year contribution limit. Assuming they maintain HSA eligible coverage until December, this election allows them to contribute 100% of the $3,400 or $6,750, instead of just 75%. However, what they may not know is there is a catch. By taking advantage of the Last Month Rule, they are bound by the terms of the Testing Period. This basically states that they need to maintain HSA coverage for the following 12 months, or the amount they contributed above their calculated (75%) amount will be taxed and penalized.

People fail the Testing Period more often than you think, and it causes tax problems when they go to file Form 8889. It is difficult to predict over a year in advance what your insurance situation will be. Some events are not foreseeable. Other people don’t even know what the Testing Period is! For example, here are some common reasons people’s insurance changes and they fail the Testing Period:

Change jobs and get new insurance
Lose job and lose insurance
Change to a non HSA-eligible plan
Go onto spouse’s insurance
Change to state health insurance (Obamacare)
Go onto Medicare
Start taking Social Security

Any of the above will likely cause you to fail the Testing Period and owe taxes and penalties.

Calculating Taxes and Penalties for Failing the Last Month Rule

If you fail the Testing Period, you will have to go back and do a bunch of work for Form 8889. The IRS will have you compare the amount you contributed ($3,400 or $6,750) to the amount you could have contributed without the Last Month Rule ($2,550 or $5,062.50). The difference will be added to your taxable income for the current year and assessed a 10% penalty.

Here are the tax and penalty calculations for our previous examples. Assume you had 9 months of coverage and used the Last Month Rule to contribute the full 2017 contribution limit:

Self only: $3,400 – $2,550 = $850 added to income (taxed); $85 penalty
Family: $6,750 – $5,062.50 = $1,687.50 added to income (taxed), $168.75 penalty
if 55+: $1,000 – $750 = $250 added to income (taxed); $25 penalty in addition to above

As you can see, failing the Testing Period means writing Uncle Sam a check for taxes and penalties. For some people, this is a bad bet because they change insurance frequently, or the taxes / penalties / headache aren’t worth the additional risk. They contribute a little less this year but no big deal. For others, this is a good risk because they have stable insurance. It allows them to contribute more to their HSA and reduce current year taxes. There is no “right” answer and it is up to the individual HSA holder to decide.

Medicare Part A Retroactive Coverage and HSA’s

Medicare Part A is a government administered health insurance plan generally for people aged 65 and older. It is a form of hospital insurance that covers inpatient hospital care, skilled nursing facilities, and other types of health care services. The general assumption is that Health Savings Account holders can maintain their HSA until they begin Medicare, and then easily hop onto Medicare Part A. As you will see, this may not be so, as there are some catches with Medicare Part A that affect your HSA eligibility based on your age and enrollment date.

People over the age of 65 do not have to sign up for Medicare; they can remain on a personal insurance plan (such as an HSA) as long as they want. However, once you elect to being coverage, or begin receiving Social Security, you are enrolled in Medicare Part A. While this not only ends your HSA eligibility (see next section), it may affect your HSA eligibility in previous months. For those who begin Part A coverage after they have turned 65, there is a clause that retroactively applies Medicare coverage. It states that your coverage start date actually begins up to 6 months prior to your actual enrollment date. From the Medicare.gov website:

If you sign up within 6 months of your (upcoming) 65th birthday, your coverage will start at one of these times:

1) The first day of the month you turn 65

2) The month before you turn 65 (if your birthday is on the 1st of the month).

After turning 65, you’re coverage will be in effect (retroactively) the lessor of 1) 6 months or 2) your 65th birthday.

It is that last clause that can really affect HSA holders. It states that if you sign up for Medicare Part A after you turn 65, the coverage will retroactively be applied up to 6 months into the past. While this added “benefit” may be great and help cover some prior costs, it begs the question: what if I had an HSA during those 6 months of retroactive Medicare coverage?

Medicare Part A Affects HSA Eligibility

The short answer to the above question is “nothing good”. First things first, we need to make clear the requirements for being able to contribute to a Health Savings Account. Note that these requirements are for new contributions only; once you successfully contribute to an HSA, the funds they are yours forever. However the key word in that sentence is “successfully”, as you must be HSA eligible for the contribution to be valid. Per IRS Publication 969, HSA eligibility requires:

You are covered by a high deductible health plan

You have no other health coverage (few exceptions)

You aren’t enrolled in Medicare

You can’t be claimed as a dependent

Obviously, points 2 and 3 stick out like a sore thumb. In essence, you can be following the rules as an HSA eligible individual, and 6 months after the fact be retroactively disqualified (made HSA ineligible) due to Medicare Part A. If you are familiar at all with how HSA tax Form 8889 works, you know that this can pose some serious risks to your financial well being.

When does Medicare coverage start?

The Medicare website mentions the 6 months of retroactive coverage but is very vague as to how it applies. The answer is Medicare coverage can be retroactive up to 6 months, if you sign up after your 65th birthday. The rule is if you sign up after turning 65, the Medicare coverage will be retroactive to the lessor of 1) the first day of your birthday month or 2) 6 months. Of course the government makes such a cockamamie rule, but oh well. Here are some examples for someone whose birthday is March 30th:

Medicare starts June 1st – retroactive coverage until March 1st (birthday month)
Medicare starts September 1st – retroactive coverage until March 1st (birthday month)
Medicare starts December 1st – retroactive coverage until June 1st (6 months)

An HSA + Medicare Part A Nightmare Example

Here’s an example of how bad this can go. Paul turns 65 in January of 2016 and becomes eligible for Medicare and Social Security but chooses to keep his day job as a bass player and to maintain his HSA eligible family insurance. Being in a lucrative field, Paul contributes the maximum to his family coverage Health Savings Account each year. In April of 2016, Paul chose to make a qualified funding distribution from his IRA to contribute the maximum to his HSA.

On May 1st, 2017, Paul plays the last show of his final farewell tour and decides to officially retire. He takes some of the proceeds from the show and contributes 4 months worth of a contribution to his HSA for 2017. No longer working, Social Security seems like a good deal so he signs up to start receiving benefits. This also enrolls him in Medicare Part A, which seems like free government sponsored medical care. Paul relaxes in his Palm Springs desert home and enjoys his retirement.

The next year, Paul gets a call from his tax accountant telling him his HSA Form 8889 is a mess and he may owe penalties and taxes. Because Paul was 67 when he signed up for Medicare Part A on May 1st, 2017, the coverage retroactively applied 6 months prior to November 1st, 2016. This means that he was not HSA eligible from November 2016 – April 2017. His accountant informs him that as a result, Paul has over contributed to his HSA for the 4 months in 2017 which will have to be removed. Even worse, his accountant tells him that the qualified funding distribution he made form his IRA in 2016 has been disqualified due to something called a Testing Period – Medicare made him ineligible for HSA contributions for 2017. That money is being taxed and penalized as well. Paul woefully reviews his financial statements and is upset as he thought he was doing everything by the book. Thinking it over, he considers booking a few reunion shows with his band mates back in LA.

How to Manage your HSA with Medicare Part A

Given the fact that Medicare Part A can retroactively disqualify you from being HSA eligible, it is best to prepare for such an event and plan accordingly. This involves a combination of 1) knowing if you are at risk for retroactive coverage and 2) planning your preceding and current HSA actions appropriately. As such, we recommend the following:

Determine when you will use Medicare Part A

If you are in your 60’s, you should be thinking about when you will sign up for Medicare Part A coverage, keeping in mind that this is also triggered by beginning Social Security benefits. If this occurs when you are age 65 and 1/2 or older, you are in the danger zone of having retroactive coverage applied. If this is the case, you will want to work backwards 6 months to plan your HSA accordingly. Will the 6 months fall within 1 tax year? Or is it possible that the 6 months will straddle 2 different tax years? By my count, the latter could affect HSA decisions you make up to 18 months in advance of enrollment!

Can you opt out of Retroactive Medicare coverage?

You may be able to opt out of retroactive Medicare coverage by contacting the Social Security Administration. This is suggested in this article in InvestmentNews.com, but the idea is to 1) begin Social Security but 2) contact the SSI and request not to begin retroactive Medicare coverage. I do not know that this works, but is worth a shot if you wish to continue funding your HSA during this time.

I received the following advice from HSA Reader Steve:

I called the Social Security office today to make my Medicare Part A coverage not retroactive for 6 months. She said it could be changed, but it would take a lot of work and could delay my application by 2 months. Apparently this could have been done when I applied, so that is the time to make this election. Moreover, the retroactive coverage began 6 months prior to my application date, not the start date I requested.

If any readers have more information or have done this successfully, please contact me.

Recalculate and Reduce HSA Contributions

If Medicare Part A applies retroactive coverage and makes you HSA ineligible for those months, you need to reduce your HSA contributions for that time frame. Remember, you are not HSA eligible if you are on Medicare, and thus cannot contribute to your HSA during those months. Instead you need to make a calculate your contribution limit for partial year coverage. For example, if you are 66 years old and have HSA eligible insurance for all of 2017, but then enroll in Medicare in December, you really were only HSA eligible for 5 of those months (since the final 6 months will have Medicare coverage). As a result, you can only contribute 5/12 of your HSA contribution maximum for that year. Many people get tripped up by contributing the full year amount early in the year, which leads to excess contributions once Medicare hits. Save yourself the headache and calculate your “true” maximum contribution early on and conservatively contribute that amount, knowing that you have until tax day to make prior year contributions.

Avoid the Last Month Rule and Qualified Funding Distributions

Retroactive Medicare Part A coverage wrecks the most havoc on HSA contributions that contain a Testing Period. These include the use of the Last Month Rule (to contribute more than normal in a partial coverage year) or the Qualified Funding Distribution (contribute to your HSA from an IRA). Both of these contributions require that you maintain HSA coverage for a given amount of time known as the Testing Period (up to 1 year). The risk is that do everything right and maintain HSA eligible coverage through the Testing Period, but then Medicare comes in and applies retroactive coverage. This in fact fails you for the entire Testing Period if you have Medicare coverage for even 1 month of it. And the worst part is that the penalties for this are fairly severe. They involve walking back your contribution amount, adding it to income, and applying a tax on top of it. You will want to carefully consider the timing of these types of contributions if you are over 65 and considering Social Security or Medicare Part A enrollment.