It’s important to understand how health savings accounts and Medicare work together.
There are different tools you can use to save money for retirement. Workers commonly contribute to IRAs or 401(k)s in the course of setting themselves up for the future. But if you’re eligible for a health savings account, or HSA, then it pays to take advantage of that option.
An HSA is technically not a retirement savings plan like a 401(k) or IRA. That’s because you can take an HSA withdrawal at any time to cover qualified healthcare expenses.
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But many people opt to treat HSAs as retirement plans because funds in these accounts don’t need to be used up by a specific deadline. You can contribute to an HSA at age 32 and take a withdrawal at age 72 to cover a senior healthcare expense.
Furthermore, because HSAs are triple tax-advantaged, they offer more IRS benefits than any other type of retirement plan. HSA contributions go in tax-free, and investment gains in these accounts are tax-free, as are withdrawals used for qualified medical costs. So if you’re eligible for an HSA based on your health insurance coverage, you should do your best to not only contribute, but leave that money alone and let it grow tax-free until retirement arrives.
However, many retirees inevitably end up enrolling in Medicare, and it’s important to know how HSAs and Medicare interact. Here are some key points to keep in mind.
1. An HSA could come in handy if you retire before you’re eligible for Medicare
Medicare eligibility begins at age 65. But many people opt to retire before then. And frankly, you may be forced to retire before age 65 if you’re downsized out of a job.
That’s why it’s a good thing to carry as a large an HSA balance with you into retirement as possible. If you find yourself out of work at, say, age 64, you’ll need to secure health coverage for a year before Medicare becomes available to you.
You may, at that point, decide to sign up for COBRA to keep the health plan your most recent employer provided you with. If you have an HSA, you can use those funds to help cover your premiums, which may be very expensive once they’re no longer subsidized.
2. You can’t contribute to an HSA once you enroll in Medicare
Once you become a Medicare enrollee, HSA contributions are no longer allowed. If you continue to fund an HSA, you could face costly tax penalties.
But rest assured that the money you’ve saved in an HSA can be used to cover qualifying healthcare expenses you incur as a Medicare enrollee. You can also tap your HSA to pay for services Medicare won’t cover, like dental care and eye exams.
3. You should stop HSA contributions six months before your Medicare enrollment if you’re signing up late
One lesser-known feature of Medicare is that it offers up to six months of retroactive coverage dating back to your 65th birthday. This means that if you delay your Medicare enrollment (say, due to having group health coverage through a job) and sign up at age 67, your Medicare coverage technically begins at age 66 1/2.
Because of this, if you’re delaying Medicare, you should stop contributing to an HSA six months before the date you expect to sign up. So in this example, if you know you intend to enroll at age 67, you should halt HSA contributions at 66 1/2.
However, this rule only applies if you’re signing up for Medicare after age 65. You don’t have to halt HSA contributions ahead of your Medicare enrollment date if you’re signing up at 65. That’s because you’re not eligible for six months of retroactive coverage at that point.
To put it another way, you’re not entitled to Medicare at age 64 1/2. So there’s no reason not to fund an HSA between ages 64 1/2 and 65.
The rules of HSAs and Medicare can be a bit complicated, so it’s important to understand them well ahead of retirement. Now that you’ve gotten a primer, you’re in a better position to make the most of your HSA — but also know when it’s time to stop putting money into that account.