HSA and Medicare

Question

I am 65 and was not planning to retire until 70. I am participating in high deductible healthcare at work and was contributing to a HSA until September 2020 when I was offered early retirement. The company cannot provide the date of my retirement yet. Retirement will be sometime between January 2021 and December 2021. A date for retirement will be given later this year. Since I'm not choosing the retirement date, do you think I will incur a penalty for the HSA contributions? It's considered family HSA as my husband is in it but does not contribute (he's only 61). My total HSA contrib this year was only $3400. If I stopped contributing at the end of Sept., and if my last day is 12/31/20, I was wondering if there would be any penalty incurred for the HSA contributions. I believe total HSA contrib for 2020 would be 7100 and 1000 catchup? If I've only contributed $3400, would I still incur a penalty once (if) I sign up for Medicare in January 2021?

Answer 1

The concern, for anyone wondering, is that when you begin Medicare, you are retroactively covered for six months before your start date, and this coverage retroactively makes you an ineligible individual for HSA contributions.

If you have stopped your HSA contributions and only contributed $3400, there is no scenario in which you would be forced to pay an excess contribution penalty.

The worst case would be if you find out that your retirement date is January 1, 2021. This would mean that Medicare coverage would retroactively start on July 1, 2020. Your prorated HSA contribution limit for 2020 would be $4050 ($8100 * 6/12).

The date of the contributions don't matter; only the totals at the end of the year. So even though in that scenario you contributed after you were technically no longer an HSA eligible indiviidal, because your total HSA contributions for 2020 are under the limit, there is no penalty or tax on your contribution.

---

I answered a similar question for someone who was concerned about getting laid off and worried about incurring a penalty for improper HSA contributions. Let's look at the details, and see what would happen if you decide to keep contributing to your HSA for the rest of the year, and end up contributing the full $8100 in 2020:

Before you do your taxes next year, you can adjust the amount you have contributed to your HSA. If you find that you have contributed too much for any reason, you can do an excess contribution withdrawal to take out what you contributed over your limit. So if you know what your retirement date will be before you do your taxes next year and it ends up being on or before June 1, 2021, you can calculate your prorated contribution limit for 2020 and undo the excess contribution, avoiding the penalty.

(The reason I said June 1, 2021 is that six months before that is December 1, 2020, and prorated limits are based on the first day of the month. If you are HSA-eligible on December 1, but no longer eligible on December 2, you can still use the full HSA contribution limit.)

The only way you might get stuck with a penalty in this case is if you file your taxes still not knowing when your retirement date is, and then you find out that it is on or before June 1, but you find out too late to fix it with an excess contribution withdrawal and amended tax return by April 15. In that case, you will have made an HSA contribution of $8100, but your actual limit could end up being as little as $6750 ($8100 * 10/12). You would owe a penalty of 6% of the excess, which would be about $81, plus some additional tax.

---

If you change your mind and decide that you want to contribute the max in 2020, understanding that you may need to do an excess contribution withdrawal if your retirement date happens in the first half of next year, you might even decide to make some contributions in 2021. You know for sure that your limit will only be at most about half of the normal limit, and your limit may be zero, but you will have plenty of time to do any necessary excess contribution withdrawal in 2021 before you do your taxes the following year.