Questions about Medicare and HSAs Keep Surfacing - Part D Collisions

Questions about Medicare and HSAs Keep Surfacing - Part D Collisions

Too few Americans approaching age 65 know the ins and outs of Medicare enrollment. If they remain active at work, they must understand how Medicare enrollment works - particularly if they continue to fund a Health Savings Account.

This is the last installment in a three-part series on the interaction of Medicare and Health Savings Accounts. In previous articles, we discussed the collisions between Health Savings Accounts and both Medicare Part A and Medicare Part B.

Medicare and Health Savings Accounts have always been on a collision course. As the number of working seniors (those who remain employed after their 65th birthday) increases and Health Savings Accounts become more widespread, the conflicts between the two programs' rules affect more and more Americans. Let's dive into this issue head-on:

Medicare History and Structure

Original Medicare launched in 1965 with the introduction of Part A (inpatient care) and Part B (outpatient care). The structure mirrored private coverage of that era, when separate insurers covered care in and out of the hospital. Prescription drugs represented a very small part of medical care and weren't covered by insurance. That changed in the 1970s with the introduction of managed-care plans that integrated inpatient, outpatient, and prescription-drug coverage into a single plan.

As prescription drugs became a larger part of medical care, Americans and their political leaders began to seek coverage under Medicare. IN late 2003, Congress passed the Medicare Prescription Drug, Improvement, and Modernization Act, which created Part A (and authorized Health Savings Accounts as a bonus).

How Part D Works

Unlike traditional Medicare, Part D coverage is provided by private insurers regulated by the Centers for Medicare and Medicare Services, which oversees the Medicare program. These plans cover different drugs on different tiers, are priced by the insurers, and are sold in a competitive market. Medicare-eligible Americans can choose to waive or defer prescription-drug coverage, enroll in Part D if they're covered by either Part A or Part B, or receive pharmacy benefits through Medicare Part C, also called Medicare Advantage - a private alternative to the Medicare program.

Part D Eligibility and Price

Anyone enrolled in Part A or Part B can choose Part D coverage. As noted above, these plans are offered by private insurers and are priced by those insurers. The average premium during the past two or three years has hovered in the low $30s. In 2023, it's $31.50 (down from $32.08 in 2022). Plans cover different drugs on different cost tiers and may change their coverage year-to-year, so prospective and active enrollees must review their prescription-drug usage annually if they want to enroll in the most cost-effective plan for themselves.

Deferring Part D and MCC

No one is ever required to enroll in Part D, unlike Part A and Part B (in which enrollment is triggered by collecting Social Security or Railroad Retirement benefits at age 65 or older). Some healthy seniors never enroll in Part D, although most Americans find it beneficial to secure prescription-drug coverage once Medicare becomes their primary coverage for inpatient and outpatient services.

But like other parts of Medicare, Part D is designed to reduce adverse selection - eligible individuals' delaying enrollment until they need coverage. Medicare imposes penalties for deferred enrollment unless you have prescription-drug coverage at least as rich as Medicare beginning in the month that you turn age 65. This concept of coverage at least as rich as Part D is called Medicare Creditable Coverage, or MCC.

Note that the penalty structure is very different from Part A and Part B. You can defer Part A and Part B coverage indefinitely and pay no penalty if you transition from employer-sponsored coverage to Medicare within eight months. Part D offers no such leniency for group coverage.

Example: Paulo remains covered through age 68 on his employer's HSA-qualified plan with a $3,000 self-only deductible. He retires and enrolls in Medicare promptly. He faces no penalty for deferring enrollment in Part A or Part B because he's coming directly from group coverage. He faces a Part D penalty if his employer's plan's pharmacy benefit wasn't at least as rich as Medicare's (which, with a $3,000 deductible that applies to all non-preventive prescription drugs, it probably isn't).

The Part D Penalty

The Part D penalty looks a lot like the penalty for deferring Part B (a lifetime 10% premium surcharge for each 12-month period that you defer Part B without employer-sponsored coverage). The Part D penalty clock begins ticking on the month of your 65th birthday. Any month that your prescription-drug coverage (whether through an employer, a continuation of a group plan through COBRA, or no insurance) is less rich than Medicare's pharmacy benefit, you are assessed a penalty equal to 1% of the average Part D premium. That penalty, like Part B's, is permanent and based on a percentage of the monthly premium, so the dollar amount increases as premiums rise over time.

Example: Nicole remained enrolled on her company's HSA-qualified medical plan and defers retirement until her 67th birthday, when she enrolled promptly in Medicare. Her employer-sponsored Rx coverage didn't meet MCC requirements. She was assessed a penalty of a permanent premium surcharge equal to 24% (for 24 months of non-MCC coverage beginning at age 65) of the average Part D premium. In 2023, that surcharge is $7.56 (24% of $31.50), whether her premium is $10 or $75. Thus, if her plan has a $35 premium in 2023, she will pay $42.56 monthly for her Part D coverage.

Should You Avoid the Penalty at All Cost?

You may be inclined to avoid the Part D penalty. After all, a penalty is typically punishment for behaving improperly. It would be more accurate to call the Part D penalty a surcharge, which has a far different connotation. We may be assessed a surcharge if we buy tickets at the gate rather than online before the event (or complete our purchase weeks in advance online rather than at the box office), or if we pay our auto insurance in monthly installments rather than up-front. That additional fee isn't a penalty, but rather a financial burden that we choose to assume because it is more advantageous to us than the surcharge-free option.

You can avoid the additional premium only if you enroll in Medicare around your 65th birthday or remain covered on a medical plan that meets MCC requirements. HSA-qualified plans often don't satisfy this standard. You'll know whether yours does because your insurer will inform you annually.

It may make more sense to defer enrollment in Medicare and accept the premium surcharges (as I will when I turn age 65 shortly). If you're happy with your (or your spouse's) employer's coverage, why spend additional money monthly to enroll in Part A (no premium for most Americans) and Part D? Sure, you could enroll in low-price Part D coverage - let's say $20 per month - and pay a small amount ($240 in this example) annually to avoid future surcharges.

But what if you're funding a Health Savings Account? In 2023, you can contribute $8,750 if you have family coverage. If you're in the 24% federal marginal income tax bracket and pay 5% of your income to the state, your total tax savings (including federal payroll taxes) exceed $3,000 in 2023. If you defer enrollment for three years (to age 68) and fund your Health Savings Account to the maximum each year, you'll save close to $10,000 in taxes and have more than $25,000 of additional Health Savings Account balances. Yes, you'll pay a 36% lifetime surcharge on your Part D premium. But that's only about $10 per month at today's rates, or $120 per year. Even as Part D premiums rise in the future - let's say the average annual surcharge during the rest of your life is $200 annually - your tax savings will exceed your lifetime surcharges unless you live past age 118. But note that your balance is probably growing - tax-free - during the intervening half century, and distributions to pay Medicare premiums - including late-enrollment assessments - aren't included in taxable income.

Are All HSA-qualified Plans Non-MCC Compliant?

No. Not all HSA-qualified plans fail to meet the MCC standard. Each year, insurers run each of their plans through a formula created by CMS to determine whether that plan meets the MCC standard. A plan with a deductible on the lower end of the statutory minimum annual deductible for an HSA-qualified plan ($1,500 for self-only and $3,000 for family coverage) may satisfy the standard. In addition, a pharmacy benefit that covers preventive prescription drugs below the deductible (often with a small copay) may also keep the plan compliant. In these cases, you face no permanent premium surcharge if you defer enrolling in Part D when you turn age 65.

What Can Employers Do?

Employers who want to help their working seniors avoid permanent premium surcharges can take one or a combination of several steps:

  • Offer an HSA-qualified plan that's MCC-compliant. Any plan change will apply to all employees. Lowering the deductible from $2,500 to $1,500 for single coverage may raise the premium (most of which the employer pays) beyond what's affordable to the company. But retaining the deductible and moving to a preventive drug rider (which often raises premiums 0.5% or less) may be an affordable option.
  • Integrate a Post-Deductible HRA. A Post-Deductible Health Reimbursement Arrangement is an employer-funded account that can begin to reimburse claims once the employee has incurred claims above the statutory minimum ($1,500 and $3,000 in 2023). This arrangement reduces the effective premium. The insurer tests the medical plan without incorporating the effects of the HRA. Insurers usually are reluctant to test a plan that incorporates their medical plan with an HRA designed and administered by another party. An employer can approach an independent actuary to determine whether the medical plan and HRA combined meet the MCC standard.

The Bottom Line

If you're funding a Health Savings Account, you must understand that age 65 is an important event in terms of your medical coverage for the rest of your life. You can defer enrollment in Part A and Part B and incur no future premium surcharges if you remain enrolled on employer-sponsored coverage. But Part D lifetime surcharges are based on different criteria, so group coverage alone isn't sufficient to waive surcharges.

To optimize your financial position, think carefully (and consult with a well-versed retirement advisor who understands Health Savings Accounts and Part D penalties) about the trade-offs in enrolling promptly or deferring enrollment in Part D. You may find that it makes sense financially to defer enrollment and pay a lifetime premium surcharge when that action is weighed against tax savings and accumulation of funds that can be spent tax-free on qualified expenses in retirement.

#HSAMondayMythbuster #HSAWednesdayWisdom #HSA #HealthSavingsAccount #TaxPerfect


William G. (Bill) Stuart

Nationally recognized expert on reimbursement account strategy and compliance, particularly Health Savings Accounts and ICHRAs 🔹Writer🔹Author🔹Speaker🔹Educator🔹Strategist

1y

Key point: It may make sense financially to defer Medicare enrollent and continue to pay the "penalty." This approach would seem more attractive if the penalty were called a surcharge. No refs' throwing flages here to assess a penalty because you did something wrong. More like accepting the trade-off when you win the coin toss and defer until the second half - you gain a long-term advantage, and at the same time you recognize and are willing to accept the price that you pay for that benefit.

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