Nearly Half of U.S. Workers Say Health Costs Are Hurting Retirement Saving, and a Social Security Filing Error Can Trigger an HSA Tax

Quick Read

• 47% of U.S. workers say healthcare costs are getting in the way of retirement saving, which makes HSAs an important tax-advantaged tool.

• Applying for Social Security at age 65 or later can start Medicare Part A retroactively for up to six months, turning HSA deposits made during that period into excess contributions.

• Uncorrected excess HSA contributions can face a recurring 6% IRS excise tax each year, so contributions should be stopped well before filing.

Healthcare expenses are straining retirement plans well before retirement begins. In WTW's Global Benefits Attitudes Survey, 47% of U.S. workers said medical costs are a barrier to saving for retirement.

That is one reason a health savings account, or HSA, can be so valuable. Contributions go in tax-free, grow tax-free and can be withdrawn tax-free for qualified medical expenses. Consider a typical example: an operations manager keeps working beyond 65, remains on an employer HSA-eligible high-deductible plan and continues contributing $500 a month to an HSA. At 67, he applies for Social Security.

He believes he has followed the rules. But filing for Social Security can retroactively create an HSA tax issue, even if he is still employed and covered by his workplace health plan.

Social Security Filing Can Retroactively Start Medicare

When someone age 65 or older applies for Social Security retirement benefits, premium-free Medicare Part A is generally triggered automatically. The two programs are linked, so collecting Social Security usually means enrolling in Part A.

There is an important catch. For someone applying at 67, coverage can usually be dated back six months before the application, even if the person did not request it. In this example, the worker could learn that Medicare had been in effect for half a year without his realizing it. At $500 a month, that would mean $3,000 in HSA contributions made during a period when he was no longer eligible.

Retroactive Coverage Can Turn Legitimate Deposits Into Excess Contributions

Under federal tax rules, your HSA contribution limit is zero for the first month you are entitled to Medicare and for every month after that. The IRS applies the same standard to retroactive coverage, so you are treated as a Medicare enrollee for those earlier months even if you were unaware of it at the time.

Those backdated months can create excess HSA contributions. Your annual limit shrinks because Medicare coverage makes you ineligible for those months, and employer deposits count toward the same cap. If total contributions go above the allowed amount, the excess loses its tax benefits and can lead to added taxes.

How serious the problem becomes depends on two factors: how far back Part A is dated and how much money was contributed during that period. Someone making the maximum family contribution would face more exposure than a worker saving a smaller amount.

The 6% Tax Can Repeat Every Year

If excess HSA contributions are left in place, the IRS can impose a 6% annual tax on the remaining excess, subject to the account's year-end value. The charge can continue in later years until the problem is fixed. It is one of several obscure IRS rules that can drain retirement savings over time.

The remedy is straightforward if caught in time. Withdraw the excess contributions, plus any earnings on them, by the tax filing deadline for the year they were made, including extensions. The earnings must be reported as other income, and the excise tax is avoided on the amount removed.

How to Stop HSA Contributions Before Filing

1. Stop your own payroll contributions early. If you plan to apply for Social Security after 65, Medicare recommends ending HSA contributions six months in advance so retroactive Part A coverage does not create a tax issue.

2. Stop employer contributions too. Employer deposits count against the same zero limit, so ask HR to turn them off on the same timetable.

3. Coordinate your filing date with payroll. Pick your application month first, then make sure your final HSA payroll deduction happens before the retroactive window begins.

The money already in the account is not lost. The balance remains yours, and qualified medical withdrawals stay tax-free after Medicare begins. Once you reach Medicare age, the 20% penalty on non-medical withdrawals no longer applies, although such withdrawals are still taxed as ordinary income. Only new contributions have to stop.

Review the HSA Cutoff Before You Submit

The best time to protect an HSA is before applying for Social Security. Work backward from your planned filing date and make sure both you and your employer stop contributing early enough. That one step can protect years of tax-free savings from a penalty that can keep recurring.

If someone has already filed and continued contributing, the withdrawal deadline provides a way to correct the mistake. Because Medicare start dates and employer plan details can differ, a quick call to Social Security to confirm when Part A would begin can help avoid an expensive error.

Help Avoid These Retirement Mistakes Before They Derail Your Future

One investment mistake could create big risks for your retirement. Many investors make the same critical errors: being too conservative, making big bets on “sure things,” or paying excessive fees. Any of those missteps can endanger hard-earned savings.

You can learn the mistakes even experienced investors make, and ways to avoid them before it is too late, with this guide: 13 Retirement Mistakes and How to Avoid Them from Fisher Investments. (sponsor)