Can Retirees Use HSAs?

Yes – and no.  A Health Savings Account (HSA) is like an IRA but for the payment of medical expenses instead of retirement income. HSA contributions are not taxed, and like IRA accounts, they belong to the employee. No matter how many times an employee changes jobs, the money in the HSA goes with the employee. Ideally, HSA contributions are invested rather than spent for immediate needs.  Over time, these investments can increase and after retirement will be available for the payment of eligible medical expenses.

In order to qualify for an HSA offered by an employer, the employee must also be covered under a High Deductible Health Plan (HDHP). The employee cannot also be covered under another health plan that provides coverage for any benefit that is covered under the HDHP.  For this reason, employees cannot participate in a Health Flexible Spending Accounts (Health FSAs) or Health Reimbursement Arrangements (HRAs) while they are contributing to an HSA, unless the Health FSA or HRA does not provide coverage included in the HDHP. These plans are called limited purpose FSAs/HRAs.

So what are the rules for retirees?  First, anyone entitled to Medicare cannot at the same time make contributions to an HSA.  Entitlement to Medicare is different from eligibility. Persons 65 or older are eligible for Medicare, but unless an individual actually enrolls in Medicare, the prohibition against maintaining a separate HSA does not apply.  Be careful!  Any person 65 or older who enrolls in Social Security is automatically enrolled in Medicare with an effective date that is retroactive for the six months preceding the Social Security enrollment.  As a result, in order to continue contributing to an HSA, an individual must not only decline Medicare but also defer Social Security.
 
Next, even though a Medicare-entitled individual cannot open or contribute to an HSA, funds in an existing HSA can still be used on a tax free basis to pay eligible medical expenses so long as the expense is covered by insurance or another arrangement. Finally, because an HSA can be used to pay the qualified medical expenses of a spouse or tax dependent, an employed spouse can pay the eligible medical expenses of the retired spouse.

In sum, although retirees can’t open or contribute to an HSA, there is enough flexibility in the rules to enable retirees to take advantage of the funds that have been set aside in these non-taxable accounts.

Flexible Spending Accounts Become More Flexible

Flexible Spending Accounts (FSAs) or Health FSAs for years have let employers provide pre-tax dollars through employee salary reductions or employer contributions to an FSA account that the employee can spend as he or she pleases for qualifying medical expenses.  The down side, especially if the FSA account were composed of salary reductions, was the “use-it-or-lose-it” rule.  This rule meant that unused money in an FSA account was forfeited at the end of the plan year.  Naturally, this led to end of year buying binges by employees who did not want to leave unused FSA money on the table.  Not only did this encourage potentially unnecessary spending but it also prevented employees from setting aside unused funds for a rainy day when a few extra dollars might go a long way to offsetting unexpected medical expenses during the next plan year.

Recognizing this problem, the IRS in 2005 allowed employers to include in their FSA plans a grace period of up to 2 ½ months after end of the previous plan year for employees to spend amounts left in their FSA account.  For the first time, Health FSAs, like Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs), gave employers and employees the ability to moderate spending that was encouraged by the “use-it-or-lose-it” rule.

In late October of this year, the Treasury Department announced a new option that gives FSAs greater flexibility.  FSAs can now offer a $500 maximum rollover option that lets employees spend unused FSA account balances during the next plan year.  Not only does this defuse employee ill will caused by the forfeiture of unused balances, the new rule also lets the employee use the saved money after the expiration of the optional 2 ½ month grace period that was permitted under previous guidance.  Although the employer has to choose between the grace period option and the rollover option (a plan cannot have both options), it is clear that employees who are careful with their FSA money can look forward to managing those funds in a way that maximizes their usefulness, especially where medical expenses in a given plan year exceed the maximum amount (up to $2,500) that can be contributed to a Health FSA.

Overall, this small change is the kind of flexible thinking that makes a Flexible Spending Account a useful way to promote prudent use of healthcare resources.  For those employers who offer Health FSAs, it is a small but not insignificant way to make healthcare more affordable for everyone.

Authored By: Randall Weill, a partner in Preti Flaherty's Labor and Employment Group.