June 19, 2018
Authored by: Meredith Jacobowitz and Sarah Bhagwandin
Employers who offer high deductible health insurance plans to their employees typically also offer Health Savings Accounts (“HSAs”). HSAs allow employees to pay for uninsured medical expenses with pre-tax dollars and are set-up under Internal Revenue Code Section 223. HSAs are subject to annual contribution limits—single individuals may contribute up to $3,450 for 2018, families may contribute up to $6,900 for 2018, and individuals over the age of 55 may contribute an extra “catch-up contribution.” In most years, determining an employee’s maximum allowable contribution to an HSA is straightforward—an employee is either covered by a high deductible health plan or not, their spouse or dependent(s) are either covered by a high deductible health plan or not, and the employee is either at least age 55 or younger. However, in the year that an individual turns 65, determining the maximum allowable HSA contribution can become tricky. Read on to learn more about this complicated issue!
HSAs may only be used by “eligible individuals,” as defined in Internal Revenue Code Section 223(c)(1). To qualify as an eligible individual, an individual must be enrolled in a high deductible health insurance plan. In addition, to be an “eligible individual,” an individual may not be enrolled in any other health plan, including Medicare. Eligibility to contribute to an HSA is determined on a month-to-month basis, so if an individual enrolls in any other non-high deductible health plan, that individual ceases being an eligible individual for the HSA in that month and for the remaining months of the year. Note, they do not lose eligibility retroactively for months preceding their enrollment.
The rules for HSA eligibility frequently create problems for employees with HSAs in the year that they turn 65 and start taking Social Security benefits. This is because when an individual who is 65 commences Social Security benefits, that individual is automatically enrolled in Medicare Part A. In fact, there is no way to “opt out” of being enrolled in Medicare Part A — and once an employee or spouse is enrolled in Medicare Part A, they are no longer eligible to make contributions to an HSA.
To complicate the contribution calculation, in the year an employee turns age 65 and commences Social Security benefits, enrollment in Medicare Part A will apply retroactively up to six (6) months. If someone commences Social Security benefits within six months of turning 65, they receive Medicare Part A coverage beginning in the month they turn 65. If an individual commences Social Security benefits more than six months after turning 65 the individual is enrolled in Medicare Part A retroactively six months prior to their application.
Because enrollment in Medicare Part A makes an individual ineligible to contribute to an HSA, the year an individual is enrolled in Medicare they must pro-rate their HSA contribution. The individual prorates the HSA contribution based on how many months of the year they are an “eligible individual.” The two examples below demonstrate the pro-rating calculation:
Joe turned 65 in January, 2017 and elected to contribute the maximum amount for a single employee to his HSA account for the year. Joe retired in September (9 months after he turned 65), and commenced Social Security benefits at that time. When he commenced Social Security benefits in September, Joe was automatically enrolled in Medicare Part A. Because Joe was enrolled in Medicare more than 6 months after he turned 65, he received Medicare Part A coverage six (6) months retroactively, to April. This means that Joe was only an eligible individual for HSA purposes for 3 months out of the year (January – March). Consequently, Joe must pro-rate his HSA contribution for 2017 based on how long he was an eligible individual. Based on these facts, for 2017, Joe may contribute the sum of the following amounts:
- 3/12 x the Maximum Single Contribution; and
- 3/12 x the Catch Up Contribution
If during 2017 Joe contributed a greater amount to his HSA than the amount calculated above, he has until the due date of his federal tax return, with extensions, to remove the excess amount without penalty. For tax purposes, the “excess amount” includes the excess contributions and any interest earned on those excess contributions. Joe should contact either his HSA provider or his employer to remove the excess amounts from the HSA. Finally, Joe should include any excess amounts as income on his tax return.
If Joe contributes a greater amount to his HSA than the amount calculated above and he does not remove the excess amount by the time he files his taxes, Joe will be required to pay income tax plus a 6% penalty tax on the excess amount in his HSA. Joe will be required to pay the 6% penalty tax on the excess amount each year until he removes the amount (including interest) from his HSA.
Jack and Janet are married and both are enrolled in Jack’s employer’s high deductible health plan. Each year the couple contributes the maximum allowable family contribution to their HSA. In 2019, Janet turns age 65 and retires while Jack continues to work. Janet turns 65 in July and commences Social Security benefits in October. Because she applies for benefits within 6 months of turning 65, her Medicare Part A coverage applies retroactively to the month in which she turned 65, July. As a result, Janet is an eligible individual for purposes of making HSA contributions for only 6 months out of 2019 (January – June). Jack turns 65 in 2020 and has not yet commenced Social Security benefits, so he remains an eligible individual for HSA contributions for 2019. In 2019, because Janet was only an eligible individual for half of the year (January – June), to determine the appropriate amount to contribute to their HSA Jack and Janet should add up the following amounts:
- 6/12 x the Maximum Allowable Family Contribution for 2019, for the months that both Jack and Janet were eligible individuals (January – June);
- 6/12 x the Catch Up Contribution for 2019, for the months that Janet was an eligible individual (January – June);
- 6/12 x the Maximum Allowable Single Contribution for 2019, for the months that Jack was an eligible individual and Janet was not (July – December); and
- 1 x the Catch Up Contribution for 2019, because Jack was an eligible individual all year.
If at the end of 2019 Janet and Jack discover that they contributed more to their HSA than the amount calculated above, they may remove the excess contributions and any interest earned on the excess contributions by the due date of their federal tax return, with extensions, without penalty. Janet and Jack should contact their HSA provider or employer to remove the excess amounts from the HSA and include the excess amounts as income on their tax return.
Like Joe, if Jack and Janet contribute a greater amount than the amount calculated above to their HSA in 2019, and they fail to remove the excess amount by the time they file their taxes, Jack and Janet will be required to pay income tax plus a 6% penalty tax on the excess amount in their HSA. And, like Joe, until Jack and Janet remove the excess amount from their HSA, they will be required to pay a 6% penalty tax on the excess amount.
As illustrated above, especially when a spouse is contributing to the HSA and is enrolled in Medicare in a year different from the employee, these rules can become somewhat complicated. Reach out to the Bryan Cave Leighton Paisner LLP Employee Benefits team to learn more!