Personal Finance

Near retirement? Avoid these 3 hiccups with your health savings account

Key Points
  • Health savings accounts work alongside high-deductible insurance plans, providing a way to save for medical costs on a tax-advantaged basis.
  • In 2020, savers can put away up to $3,550 if they have single coverage or $7,100 for family plans. Add another $1,000 if you’re over age 55.
  • If you’re approaching Medicare eligibility, pay close attention because you can botch your HSA contributions. Excess HSA contributions may face a 6% tax.
Thomas Barwick

Health savings accounts can be a great tool for retirement medical costs — if you don't make any mistakes using them.

These accounts work alongside high-deductible health plans and they offer three major tax benefits.

First, you can make pretax or tax-deductible contributions to your HSA. Second, your funds will grow tax free – and you can use the money on a tax-free basis to pay for qualified medical expenses.

There's an added sweetener for people who have these accounts at work: Your contribution, as well as whatever money your employer kicks into the HSA, avoids Social Security and Medicare taxes.

The funds will come in handy once you retire.

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A 65-year-old couple who retired in 2019 can expect to spend $285,000 in health-care and medical costs through retirement, excluding the cost of long-term care.

To offset some of that, savers can stash up to $3,550 in a health savings account this year if they have single coverage or $7,100 for family plans. Add another $1,000 if you're over age 55.

"You can use the funds for qualified medical expenses, and that will always be tax-free for you," said Shobin Uralil at Lively, an HSA provider. "There is no time horizon."

There's a catch, however: If you plan on remaining in the workforce through your 60s, pay close attention to how you fund this account.

Here are three potential hiccups older savers might face.

1. You held off on Social Security and Medicare

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Older workers may decide to boost their savings by waiting to claim Social Security and go on Medicare.

If you wait until after full retirement age to claim Social Security — which is about 66 for people born between 1943 and 1959 — you're offered a lump sum of retroactive benefits going back to six months.

If you take the lump sum benefits, you've also retroactively signed up for Medicare going back as far as six months.

You're not allowed to enroll in Medicare and continue saving in an HSA.

"If you're someone who applied for Social Security in that retroactive period, it means you've also made excess contributions to your health savings account," said Oscar Vives Ortiz, CPA and member of the American Institute of CPAs' personal financial specialist committee.

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Head off trouble when you sign up for Social Security; tell your representative not to provide you any retroactive benefits.

Let's say you made those excess contributions last year. In that case, you have until April 15 — the due date of your 2019 tax return — to retrieve the money.

Failure to do so could mean you're on the hook for a 6% excise tax and income taxes. Any excess HSA contributions your employer made are also included in your gross income.

"Take the excess contributions out before you file your tax return," said Vives Ortiz. "That includes the contributions and the earnings associated with them."

2. You're covered only part of the year

Klaus Vedfelt

If you wind up leaving your plan at some point in the middle of the year, remember that you can no longer make a full year's contribution to your HSA.

Instead, you'll need to prorate your contributions for that year, dividing the maximum by 12 and multiplying by the number of months in which you qualified to contribute.

Let's say you're a single person who's eligible to contribute $3,550 to your account, plus the $1,000 catch-up.

You've left the plan as of July 2020. In that case, you can put away a maximum of $2,275 — the annual contribution and the catch-up, prorated for six months of HSA eligibility.

"If you're doing payroll deductions into the HSA, talk to your payroll provider," said Vives Ortiz. "If you're self employed and saving in your own account, just stop the contributions."

3. You used your HSA to buy insurance

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Qualified medical procedures aren't the only thing that you can pay for with HSA funds.

Premiums for long-term care insurance, as well as the cost of Medicare if you're 65 and over are also applicable expenses.

Just be aware that premiums for Medigap — supplemental Medicare plans that help you pay for deductibles, copayments and coinsurance — are not HSA-eligible.

Further, if you used HSA money to pay for qualified medical expenses, you're not allowed to claim an itemized deduction for those health-care costs.

"You would be double-dipping," said Vives Ortiz.

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