We can say two things for sure about the American workforce and its health insurance. First, more Americans are working past the traditional retirement age of 65. Second, more are taking advantage of employer insurance plans that include tax-exempt Health Savings Accounts.
Add these two facts together, and you end up with a pitfall that could cost unwary American workers as much as $2,700 a year in tax exemptions if they exercise their right to enroll in Medicare at 65. That pitfall exists because of the confusing way HSAs interact with Medicare, and because many big employers fail to help their older employees deal with the potential complexities—or even to know about them.
"If you're working for a large employer," says Lawrence Kotlikoff, a Boston University economist and co-author of the book "Get What's Yours," an excellent guide to the intricacies of Social Security, "you've got to think twice about signing up for Medicare."
We'll explain why in a moment. First, a quick primer on Health Savings Accounts.
These accounts allow workers to sock away funds tax-free for withdrawal later to cover a host of medical expenses not paid by insurance—deductibles, co-pays, eyeglasses, orthodontia, etc., etc. There's no tax on withdrawals if the money is spent on such medical expenses, which after 65 can include Medicare premiums. The 2018 maximum family contribution of $6,900 would yield a maximum tax break of about $2,732 to a family paying the top marginal income tax rate of 39.6%. Typically, employers contribute a few hundred dollars per family member, also tax-free, to get the account launched.
HSAs must by law be tied to a high-deductible health plan, defined as one with a deductible of at least $2,600 for a family. Those are more common among employer-sponsored health programs, as are HSAs.
Companies favor high-deductible health plans coupled with HSAs because they tend to charge lower premiums, which help workers and employers alike. The higher deductibles reduce risk to the employer, albeit by shifting it to the worker. For those and related reasons, the percentage of big corporations offering HSAs to workers has risen to 87% from 51% among big employers since 2010; similar trends are seen among medium-sized and small companies.
The number of account holders has risen to 5.5 million from 800,000 in 2010, according to the Employee Benefit Research Institute. Total balances have risen to $11.4 billion from about 1.5 billion in 2010. Expect both figures to keep climbing.
HSAs offer considerable benefits to certain households. The balances can be rolled over year after year, so users can accumulate a sizable medical nest egg to use when they do get sick or hurt. Still, we've never been a big fan of HSAs and high-deductible plans from a public policy perspective. They're geared toward wealthier taxpayers, who have the spare cash to deposit and will reap the largest tax breaks. They're much more inviting for families that don't expect to have major medical expenses than for those with costly chronic conditions or lack the resources to cover their higher out-of-pcket expenses.
In the words of David Anderson, Duke University's health insurance guru, HSAs are "good for people who have very strong reasons to believe that they are healthy and have sufficient access to resources to afford the high deductible after they get hit by a meteor." They're also dangerous for the healthcare system overall. That's because they can bifurcate the insurance pool, potentially luring younger, healthier customers out of the pool and leaving those expensive, unlucky patients for whom HSAs are unsuitable to face higher premiums.
Moreover, HSAs didn't originate as an answer to the inadequacies of the U.S. healthcare system; they sprung from the brain of an insurance man named J. Patrick Rooney, who saw them as a nifty product for his Golden Rule Insurance Co., which later was acquired by the big insurer United Health Group. Rooney and his employees contributed more than $1 million to the GOP and Republican candidates during the mid-1990s. Then-House Speaker Newt Gingrich saw HSAs as a tool to get Medicare to "wither on the vine" by giving seniors an incentive to "leave it voluntarily."
That didn't happen. Instead, Medicare and HSAs worked on each other like sour milk. Under the rules, HSA contributions can't be tax-free if the contributor is covered by any health plan except a high-deductible policy. Medicare doesn't qualify. As a result, people enrolled in Medicare lose their eligibility to contribute to an HSA from pre-tax income, even if they're also covered by a high-deductible policy. If they already have funds in an HSA, however, they still can spend them on medical expenses tax-free.
None of this matters to most people younger than 65, the Medicare eligibility age. But more workers are staying on the job past 65. That means more people need to decide whether to enroll in Medicare, keep their employer plan, or both.
Conventional wisdom says that even workers with good workplace plans should enroll in Medicare Part A, which covers hospitalization. That part of Medicare is effectively free, since it doesn't carry a premium and wraps around employer plans, providing secondary coverage of hospital expenses not covered by the employer plan. The exception is for workers at businesses with fewer than 20 employees, for whom Medicare becomes the primary insurer; in most cases, they should enroll. (Medicare Part B, which covers doctor visits, and Part D, the prescription drug benefit, do carry premiums, so many workers with good insurance generally put off enrolling in those programs until they retire.)
It's important to know that it's enrollment in Medicare, not eligibility, that kills the HSA tax break. Knee-jerk enrollment in Part A will make the employee ineligible to make tax-exempt HSA contributions. (If only one spouse is covered by Medicare and both are covered by a high-deductible plan, HSA contributions can be made for the non-Medicare spouse.)
One more wrinkle: People 65 and older with employer health plans can decide whether and when to enroll in Medicare Part A, unless they're already taking Social Security benefits, including disability payments. For them, Medicare Part A enrollment is usually automatic, and unavoidable.
Put all this together, and it means that many workers planning to stay on the job and invest in an HSA should be careful about enrolling in Medicare at age 65.
These considerations don't apply equally to every employee working past 65, but are germane to people planning to make HSA contributions after they become eligible for Medicare. And individual considerations are what count. Anyone confronting this dilemma should consult his or her HR department and a tax advisor.
The real problem is that employers often don't caution their older workers about the Medicare pitfall. "Employers have an obligation to inform their employees how to handle Medicare," Kotlikoff told me, but it may be rare that they do. He notes that his employer, Boston University, has never sent him a notice about the Medicare/HSA conflict, even though he's 66. People in his position "have got to be careful about signing up or not signing up," he says. "It can hurt them." The decision is ripe for most workers at companies with health plans, since open enrollment periods for 2018 coverage have already begun or will soon.
Unfortunately, the only sources most workers have for advice on HSAs and Medicare are their employers, who haven't been too clear on the issue. Customer service staffers at Medicare and Social Security are likely to deflect questions about HSAs to your HR department. But with so much money at risk to an ever-larger cadre of older workers, the information gap is a problem—and for some workers, it could be a crisis.