The number of Americans enrolled in HSA plans has steadily increased over the years, which is a step in the right direction. While health savings accounts provide several significant long-term benefits, you'll want to take into account certain considerations before enrolling. What's more, understanding how HSAs integrate with Medicare is something most people are not aware of, but they should be. It's imperative to understand their interplay because if implemented incorrectly, resolving the issue could cost considerable time and money (penalties). This blog post will discuss this topic and some common misconceptions about HSAs.
The High-Deductible Health Plan (HDHP)
To qualify for a health savings account, you must be enrolled in a high-deductible health plan.
Unlike a traditional health plan, a high-deductible plan offers lower monthly premiums but a higher out-of-pocket deductible. The maximum out-of-pocket costs for HDHPs vary depending on the plan.
You may be asking yourself why someone would subject themselves to a potentially higher annual out-of-pocket risk. This is where the HSA comes into play. If implemented properly, the benefits are immense.
Before diving in, it needs to be stated that HSAs work best for those with positive cash flow and a healthy cash reserve. That way, you can cover the out-of-pocket deductible without disrupting your other financial obligations.
Medicare
Most Americans enroll in Medicare Parts A and B in the month of their 65th birthday. Individuals are eligible to sign up during the three months before turning 65, during their initial enrollment period (IEP).
Enrolling in Part A or B means you are no longer eligible to contribute to an HSA. The same applies to Medicare Advantage plans.
Let's look at this example:
Lisa, who turns 65 on December 15, plans on enrolling in Medicare. Therefore, she must stop her HSA contributions as of November 30. This means she can fund 11/12 (~92%) of the annual HSA maximum.
What about those who plan on working past age 65? Things can get a bit tricky.
When working for an employer after age 65, assuming the company has more than 20 employees, you can delay enrollment, continue your employer coverage, and fund an HSA.
Now, the next part is important. While this decision allows you to delay enrollment, you MUST STOP HSA contributions six months before applying for your delayed benefits. This is because Medicare has a six-month retroactive start date and is not a high-deductible health plan, thus eliminating HSA eligibility. You need to plan carefully when transitioning from an HDHP to Medicare to avoid making excess HSA contributions.
Let's take a look at an example:
Lisa, age 66, has delayed Medicare enrollment as she continues to work. She contributes to an HSA since she's enrolled in a high-deductible plan through her employer. Lisa plans on retiring on January 1, 2026. Since she delayed Medicare enrollment, Lisa must stop HSA contributions on July 1st, 2025, six months before her January 1 retirement date. This means she can fund 6/12 (50%) of the annual HSA max in 2025.
What happens if Lisa is married? Well, that complicates things a bit further.
HSA eligibility depends on which spouse owns the account. Much like IRAs and 401(k)s, HSAs are individually owned. If Lisa owns the HSA, she can continue contributing even if her husband, Tom, age 67, is already on Medicare Part A or enrolled in Social Security. Tom can postpone Part B and apply penalty-free when Lisa retires.
One potential caveat: Had Lisa claimed her Social Security benefits before age 65, she would not be eligible to contribute to her HSA once hitting age 65. Why, you may ask? Well, it concerns how Social Security and Medicare work together. Anyone collecting benefits before 65 will automatically be enrolled in Medicare A and B upon turning 65. Therefore, in this case, Lisa would have had to stop HSA contributions one month before.
While the average retirement age in America is ~65 (men) and ~62 (women), some continue to work well past these ages. Those working past 70 encounter a different set of circumstances. Maximum Social Security benefits are achieved at age 70, which means one should never delay benefits past 70, as that is leaving money on the table.
Now, collecting at 70 will require enrollment in Medicare Part A, which means HSA contributions must stop six months prior, even if you plan on working longer!
John turns 70 on October 15, 2025, and plans on working for many more years. He has delayed Medicare enrollment, as he is utilizing an HDHP through his employer and funds his HSA. John knows there's no financial benefit to delaying Social Security past 70, so he will stop contributing to his HSA by April 15, 2025, six months before turning 70.
Health Savings Account (HSA) Misconceptions
Stepping back from the interplay of HSAs and Medicare, it should be noted that HSAs provide the rare benefit of being triple-tax-advantaged vehicles. If implemented properly, these advantages can pay off in spades over the long term. With that said, there are a few common misconceptions:
Misconception: HSAs are "use it or lose it" accounts, similar to flexible spending accounts (FSAs).
HSAs can be used when needed and are portable between jobs.
Misconception: There are penalties if funds are used for anything besides qualified medical expenses.
Thankfully, this is not always the case. In fact, starting at age 65, HSA funds can be withdrawn penalty-free for any purpose and are only subject to ordinary income tax (similar to an IRA).
Misconception: The investments don't grow much.
The issue is that most HSAs default to cash, which, at best, will keep up with inflation. The good news is that HSAs have a variety of investments, similar to a 401(k)/403(b) plan. Investing these dollars over the long term is where an HSA shines. Let's take a look at an example below:
Tom, age 40, maxes his HSA in 2024 ($4,150). Let's also assume he maxes funds (not inflation-adjusted) for a total of 20 years. Given his time frame, Tom decides to invest his HSA in the stock market (S&P 500) and earns an 8% annual return. Tom's balance will amount to ~$233,658, of which ~$146,708 (~$233,658 - $86,950) is tax-free growth! Tom can also withdraw funds in a future year for expenses that took place in an earlier year.
In addition, many employers will contribute a set amount toward an employee's HSA. Just keep in mind that the annual contribution limit must include any employer contributions. As with all things, you want to be aware of the drawbacks:
As mentioned, you must be enrolled in a high-deductible health plan to qualify.
You will incur higher out-of-pocket costs before reaching your annual deductible. You'll want to consider this if you regularly incur higher medical expenses.
HSAs assess a 20% penalty for any non-medical-expense withdrawals before age 65. This penalty is in addition to the amount being taxed as ordinary income.
All contributions and distributions are reported to the IRS using Form 8889, which allows taxpayers to keep an accurate record of their HSA activity.
Conclusion
It's important to understand just how expensive healthcare can be in retirement. According to Fidelity, the average 65-year-old couple will spend ~$300,000 on health coverage over retirement! That's a staggering amount. Because 401(k)/traditional IRA withdrawals are taxed as ordinary income, large healthcare-related expenses may increase your taxes and subject you to Medicare surcharges (IRMAA). This alone could cost you tens of thousands of dollars in taxes! This is where HSAs shine.
You have much to consider when making healthcare-related decisions, especially those that can impact the long term. Understanding the interplay between your health insurance and Medicare is of utmost importance.
Discuss your situation with a fee-only financial advisor.