Tag Archives: Retirement

Using HSA Funds Once You Turn 65 Years Old

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Penalty on Non Qualified Withdrawals

Health Savings Accounts are generally required to be spent on qualified medical expenses. Contributions you make have great tax advantages based on the assumption that you will use them for their intended purpose, which is medical care for you and your family. Deviating from properly spending the funds can result in taxes due, as well as a 20% penalty. You can read about options for cashing out your HSA, but there aren’t many ways around getting money out without paying that 20% penalty.

That all changes once you reach the age of 65 years old. Besides being eligible for Medicare (which can affect your HSA eligibility), at age 65 your HSA no longer penalizes you for taking funds out of it. This is a huge advantage is your HSA becomes much more flexible and can be spent on anything, not just qualified medical expenses. This is one reason why HSA’s are a great retirement vehicle. While always avoiding tax on medical purchases, the HSA basically converts into a 401(k) or IRA (invest pre-tax, pay taxes later) at the time you turn 65. Conveniently, this is right around retirement time, so your HSA has served you like an IRA with a great medical option on it. As you will see, some distributions after age 65 will still incur a tax, but all distributions will avoid the 20% penalty. Per IRS Form 969:

Additional tax. There is an additional 20% tax on the part of your distributions not used for qualified medical expenses. However, there is no additional tax on distributions made after the date you are disabled, reach age 65, or die.

Using HSA funds for Qualified Medical Expenses at 65

Even after reaching 65, your Health Savings Account is still the best way to pay for medical, dental, or vision care for you and your family. This is because the triple-tax advantage still exists for the HSA: pre tax funds, no tax on earnings, and no tax for medical expenses. That means that any medical care you receive after age 65 is still paid for tax free using your HSA. You should remember this and guard those HSA dollars to avoid paying the tax man more than is needed.

For this reason alone, it may make sense not to use the HSA for things other than qualified medical expenses. As you will see, while you won’t be penalized on those “other” distributions, you will still be taxed, and in turn you forfeit the ability to spend those funds tax-free on medical care. Of course, even after age 65 you can still contribute to an HSA, but at that point you may not be on an HSA eligible plan or may have begun Medicare coverage, which prevents you from contributing. So once the genie is out of the bottle and the HSA funds are gone, it may be tough to get them back in and regain tax free medical spending. The point is to protect those HSA funds since they have the special ability to pay for medical care tax free, and we know that medical spending increases as we get older.

Using HSA funds for anything at 65

Above we mention the way to play this by the book, let’s talk about the fun way to use HSA funds. Once you turn 65, you can withdraw funds from your HSA without penalty. This means you can spend them on retirement, vacations, gifts for your family, fine wine and leather-bound books, or whatever you want. Any time before age 65 doing so would incur a steep 20% penalty on this “incorrect” usage of HSA funds, but in your golden years you can spend freely and enjoy the high life with your HSA. You no longer need to spend your HSA dollars only on qualified medical expenses.

After 65, HSA funds can be spent on things other than qualified medical expenses, but these amounts are added to income, which creates a tax liability.

The only downside is that you will still owe tax on these distributions from your HSA. Any funds you pull from your HSA for non qualified medical expenses will be added to income and taxed, but I argue this makes sense given the tax history of the contribution. You were able to contribute tax-free, your earnings grew tax free, and your funds need to be spent on medical expenses to continue to be tax free. Since you are not spending them on medical expenses, they are added to income like they should have been the year you made the contribution. However, at this point you have enjoyed the advantage of tax free investment growth compounded over many years.

In addition, delaying HSA distributions until this time is beneficial as your tax rate is likely lower in retirement. This results in less of a tax hit than it would have had you been taxed at the time of contribution, likely years ago. For example, at the peak of your career your marginal tax rate may have been 30%. But in retirement, you may be in a 15% tax bracket, so you have effectively arbitraged the tax system and saved yourself significant money.

Accounting for Distributions after 65 on Form 8889

Regardless of what you spend your HSA funds on, you will need to account for it each year with the IRS. This is done with HSA Form 8889 and specifically takes place in Part II – Distributions. We will examine two scenarios and how to account for them.

If you are 65 or older and use your HSA to purchase qualified medical expenses, your Form 8889 activity will look the same as if you were not 65. Specifically, you will call out the distribution, and classify it as being spent on qualified medical spending.

The following was prepared quickly using EasyForm8889.com

If you are 65 or older and you use you distribute from your HSA for something other than medical expenses, the treatment is a bit different. In this case, you call out the distribution amount but enter $0 for the amount spent on qualified medical expenses on Line 15. This will lead to taxable distribution on Line 16. However, there is a checkbox on 17a that you check for distributions over age 65, and line 17b backs these out from the 20% penalty.

This way, the amount is added back to taxable income but the penalty is avoided.

Note: if you need help accounting for your HSA distributions at age 65, please consider using my service EasyForm8889.com to complete Form 8889. It asks simple questions in a straightforward way and will generate your HSA tax forms in 10 minutes. It is fast and painless, no matter how complicated your HSA situation.

HSA 55+ Catch Up Contribution When Spouses Have Separate HSA’s

You are probably aware that Health Savings Accounts have a contribution limit that changes slightly each year, and that your coverage (self-only or family) determines how much you can contribute to your HSA. For example, the contribution limits for 2017 are $3,400 for self-only coverage and $6,750 for family coverage. In addition, there is a catch up contribution for those that are 55 or older before the end of the year in the amount equal to $1,000. The IRS defines this catch up contribution in Form 969:

Additional contribution. If you are an eligible individual who is age 55 or older at the end of your tax year, your contribution limit is increased by $1,000. For example, if you have self-only coverage, you can contribute up to $4,400 (the contribution limit for self-only coverage ($3,400) plus the additional contribution of $1,000).

To qualify for the 55+ catch up contribution, you must be 55 within the tax year, be HSA eligible, and not be enrolled in Medicare – basically all of the stuff to be able to contribute to an HSA. The only addition is the age constraint thrown into the mix. This is generally easy enough for self-only coverage, but what do you do if your spouse is over 55 and you are not? Or, what do you do if both you and your spouse have separate Health Savings Accounts? You may be surprised to learn that the $1,000 can go on different lines on Form 8889 based on your coverage situation.

Catch Up Contribution follows the HSA Holder

A guiding principle is the $1,000 catch up contribution follows the HSA account holder, i.e. you or your spouse. To determine your household’s eligibility for a 55+ additional contribution, you must determine if the HSA account holder is age 55 or older by December 31st of the tax year. If they are, you can contribute to additional $1,000 to their HSA account.

The downside is your household may not qualify based on arbitrary factors of who opened the HSA and their age. For example, assume you are over 55 but your spouse is not. If your spouse owns the HSA, neither can contribute a 55+ catch up contribution for that year, until the spouse turns 55. Only then can one extra contribution be made, even though you are already 55 or older. Again, the 55+ contribution follows the account holder, so your age (as a non account holder) is irrelevant. The risk here is you may be shortchanging your household that $1,000 catch up contribution if the HSA account holder is younger.

[The way to get around this is, assuming you are on family coverage, to open an HSA in your name, so that you can contribute that $1,000 (assuming 55+) on top of the shared regular HSA family contribution limit. See next sections.]

Both Spouses have Separate HSA

Remember when we said earlier that the 55+ catch up contribution follows the HSA account? That also applies if you have family coverage and both spouses have their own HSA in their name. However, the rule still holds that only account holders 55 or older during the tax year can contribute the $1,000 catch up contribution to their HSA.

As another example, if you have family coverage with separate HSA’s and you are over 55 and your spouse is under 55, only your HSA can receive the $1,000 catch up contribution. Since this scenario requires the HSA’s to split the family contribution limit among them, for 2017 you will divide the $6,750 up however you like but your account must have the catch up contribution in it, if you make that extra contribution.

Thus, valid contributions for 2017 might look like this for the 55+ / < 55 accounts:

$6750 / $0
$0 / $6750
$3375 / $3375
$7,750 / $0 ($1,000 catch up used)
$1,000 / $6,750 ($1,000 catch up used)

In contrast, the following contribution combinations are invalid for 2017 for 55+ / < 55 accounts:

$0 / $7,750 (can’t put $1,000 in < 55 account)
$100 / $7,650 / $0 (must put all $1,000 in 55+ account)
$999 / $6,751 / $0 (must put all $1,000 in 55+ account)

Both Spouses 55+ and have Separate HSA

If both you and your spouse are over 55, have your own HSA’s, and are on family HSA coverage, you can both contribute the $1,000 catch up contribution to each of your HSA’s. For 2017, assuming full year coverage, this would be a household HSA contribution of $8,750 ($6,750 + $1,000 + $1,000). Again per Publication 969:

If both spouses are 55 or older and not enrolled in Medicare, each spouse’s contribution limit is increased by the additional contribution. If both spouses meet the age requirement, the total contributions under family coverage cannot be more than $8,750. Each spouse must make the additional contribution to his or her own HSA.

This is a secret HSA backdoor to increase your contribution limit above and beyond the stated family contribution limit, all by opening an HSA for each spouse. Many people don’t know that they can contribute so much money to an HSA as a family. Doing so should not bring additional cost, as it requires simply opening an HSA in your name. The cost being your time, a tax form, and perhaps an account minimum, but you gain an extra $1,000 / year in triple tax advantaged contributions.

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Note: if you have an HSA, please consider using my service EasyForm8889.com to complete Form 8889 come tax time. It is fast and painless, no matter how complicated your HSA 55+ contribution situation.

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.

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Note: if you need help on Form 8889 with partial year coverage, excess contributions, last month rule, or qualified funding distributions, please consider using my service EasyForm8889.com to complete Form 8889. It asks simple questions and is fast and painless, no matter how complicated your HSA situation may be.