Is Medicare the Next Frontier for Health Savings Accounts?

Medicare is disqualifying coverage for anyone who wants to fund a Health Savings Account. Several legislative proposals may change that.

Section 223 of the Internal Revenue Code is clear (or as clear as legislative language can be) about the effect of enrolling in Medicare on a Health Savings Account owner's opportunity to fund her account:

(b)(7) Medicare eligible individuals. The limitation under this subsection for any month with respect to an individual shall be zero for the first month such individual is entitled to benefits under title XVIII of the Social Security Act and for each month thereafter.

Translation: Once you are enrolled in any Part of Medicare, neither you nor anyone else (including your employer) can contribute to a Health Savings Account). You can continue to withdraw funds tax-free for qualified expenses. But you can no longer deposit any funds into the account.

Many Americans continue to work past their 65th birthday, the point at which they're eligible to enroll in Medicare. Enrollment isn't mandatory at age 65, but some people are required to pick up Medicare coverage in specific circumstances.

This situation may change. There are proposals in the works that address some of the issues that this limitation creates for seniors. The impetus? There are some 65 million Americans enrolled in Medicare. These proposals target that entire population or subsets that are treated differently from similar people not enrolled in Medicare.

Working Seniors and Social Security

Americans who are age 65 or older and collecting Social Security or federal Railroad Retirement benefits are automatically enrolled in Medicare Part A, which covers inpatient services, home-health care, and hospice care. If you have (or your spouse has) worked 40 or more quarters (10 years) and earned a minimal amount each quarter, you don't pay a premium for this coverage. Many working seniors remain covered on their company medical plan, so Part A is additional coverage that costs them nothing. Thus, no harm.

But this provision has implications for working seniors who participate in their employer's Health Savings Account program. If they collect Social Security benefits as they remain active at work, they can no longer contribute to their Health Savings Account. Nor can their employer.

Example: Abe, Benjamin, and Cain all work for Able Printing and are enrolled in the company's Health Savings Account program. Abe is 68, earns $110,000 annually, and has deferred Social Security. Benjamin is also 68, earns only $30,000 per year and receives Social Security benefits to supplement his income. Cain is age 40 and earns $35,000. Abe and Cain can each accept Able Printing's $2,000 Health Savings Account contribution and contribute a portion of their income through pre-tax payroll deductions. But Benjamin, who earns less than either of them, can neither accept the company deposit nor contribute personal funds.

Regardless of the intent of this provision in Social Security rules, the effect is to discriminate against certain working seniors based on their age and income.

In July 2018, the House of Representatives passed legislation with bipartisan support that would allow Part A enrollees who were otherwise HSA-eligible to make and receive contributions. That bill never made it to the floor of the Senate. (It will be revived - see below.)

Working Seniors and Company Size

Working seniors employed at companies with fewer than 20 employees may be (and usually are) required to enroll in Medicare Part A and Part B. Part B covers outpatient services like physician visits, imaging, and outpatient therapy. Unlike Part A, it requires a premium of at least $170.10 in 2023 (it can be higher, depending on income).

At these small companies, Medicare is the primary insurer, even if a working senior is also enrolled in the group medical plan. The company's insurer may (and most do) require working seniors who are eligible to enroll in Medicare to pick up Part A and Part B. Why? Providers send the claim to Medicare first. It pays what it owes. Then the private insurer pays most or all (depending on the terms of its contract) of the remaining bill. The group insurer isn't willing to cover the first portion of the bill just because the employee chooses not to enroll in Medicare. So, it requires working seniors to enroll in Part A and Part B.

So, working seniors at most small companies are required to enroll in Medicare and are disqualified from making or receiving further Health Savings Account contributions, whereas their contemporaries working at firms with 20 or more employees aren't required to enroll in Part A and Part B based on company size alone. This situation, regardless of intent, looks like discrimination based on age and company size.

An industry trade group is working with a key senator on legislation that would allow anyone enrolled in Part A and/or Part B who's otherwise HSA-eligible to continue to participate in a Health Savings Account program. This bill would correct both the Social Security and small-company issues.

Health Savings Accounts for Seniors

US Rep. Ami Bera (D-CA), a Sacramento physician, and Rep. Jason Smith (R-MO), the new chair of the House Ways and Means Committee, have introduced legislation that would allow anyone enrolled in Medicare to open and fund a Health Savings Account. If enacted, this bill would open the Health Savings Account opportunity to all Medicare enrollees, not just working seniors forced to enroll in Medicare.

Example: Connie's company never offered a Health Savings Account. She is now 70, retired, and enrolled in Medicare. She can open and fund a Health Savings Account to reimburse her Medicare premiums and other qualified expenses tax-free.

The average senior spent more than $5,500 in qualified expenses in 2016 (the most recent available data), according to Kaiser Family Foundation. That figure includes $2,300 in Medicare premiums and $3,200 in out-of-pocket expenses. A typical senior who opened a Health Savings Account and redirected $3,200 of income through the account to pay those expenses would save $600 or more in taxes. That's an extra $600 annually to spend on household bills, travel, or entertainment.

The bill as introduced in the 117th (last year's) Congress would redefine Medicare premiums as non-qualified expenses. That's a take-away on the surface. But since most people don't accumulate large balances in a Health Savings Account, whether they participate during their working years or (under this proposal) only in retirement or both, excluding premiums from the list won't have a material financial effect. They'll spend their balances on Medicare cost-sharing (deductibles, coinsurance, and copays), care beyond the limits prescribed by Medicare, and services that Medicare doesn't cover (like most dental, vision, and hearing services).

Also, it would reimpose the 20% additional tax that pre-65 account owners pay when they withdraw funds for non-qualified expenses. This proposed change also should have little effect, since the most tax-efficient means of using Health Savings Account balances is to reimburse qualified expenses. Withdrawals for any other purpose are always included in taxable income.

HOPE Accounts

HealthEquity, a leading provider of Health Savings Accounts, has proposed a variation called a HOPE Account. Anyone with coverage that complied with the requirements of the Affordable Care Act could open and fund a HOPE account. Contributions by employers would be pre-tax (as under current law) and by employees would be post-tax (like a Roth retirement account). Balances would grow-tax free and withdrawals for qualified expenses would be tax-free as well.

The opportunity to open HOPE Accounts would extend to Medicare recipients as well. The tax benefit would not be as great for older Americans, however, as contributing post-tax funds and then withdrawing most of the contributions to pay that year's expenses wouldn't generate a tax advantage. But for younger Americans who aren't eligible to open and fund a Health Savings Account, a HOPE Account represents an opportunity to enjoy many of the tax benefits that a Health Savings Account offers.

Medicare Savings Accounts

Another approach is to create a type of Health Savings Account that's available to all seniors enrolled in Medicare. Currently, there is a Medical Savings Account program in Medicare, but only two insurers offer qualified Medicare Advantage plans in only a handful of counties nationwide. Thus, few seniors have access to the plan. And its benefits are much less attractive than a Health Savings Account.

A Medicare Savings Account that looks like a Health Savings Account would help seniors manage their out-of-pocket costs. It would have the same tax advantages as a Health Savings Account - including pre-tax personal contributions, unlike the HOPE Account. And anyone enrolled in traditional Medicare or a Medicare Advantage (plans offered by private insurers regulated by Medicare administrators that replace traditional Medicare) plan could participate - thus eliminating the distribution gap in the current Medicare Savings Account program.

This is an opportunity ripe for action by a politician or interest group whose goal is to help all seniors manage the cost of coverage and care without changes to the financial structure of Medicare.

The Bottom Line

Health Savings Accounts offer important benefits - tax savings, incentives to save for future medical expenses, funds for health-related emergencies - that would help all Americans. Yet due to plan design, plan distribution, and conflicts with other coverage, many people can't leverage this financial opportunity. Extending these benefits to some of or all the 65 million Americans on Medicare would help them manage their out-of-pocket expenses, increase compliance with ongoing treatment regimens, and give them a little more breathing room with their largely fixed incomes. It's a concept that appeals to seniors, their advocates, insurers, and Health Savings Account administrators.

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