Jacob Duke: Hey, friends, and welcome back to another episode of Retirement Answers. My name is Jacob Duke. I am your host as always. Today on the show, I want to talk about HSAs and not just how HSAs work. I really want to spend most of our time talking about potential risks or mistakes that you could be making as someone who's near retirement or entering retirement with your HSA.
And these are things that a lot of people are unaware of, and I want to make you aware of them here today. But if you're new here, welcome. Again, my name is Jacob Duke. I'm a certified financial planner and the owner of a retirement planning firm that helps people just like you plan smarter and retire better. Now, reason I want to talk about this idea of potential mistakes around your HSA is because I'm walking through this with a client right now, as they are going to retire later this year, mid year, and they're wondering what they can contribute to their HSA up to whatever maximum.
So we know that the HSA has an annual maximum and here in 2026, if you are over 55, you have an additional $1,000 per person catch up. And for individuals, the annual contribution max is $4,400. If you're over 55, then you get that additional 1,000 on top of that. For families, you have 8,750 is your normal contribution. So those are the annual contribution amounts.
But the weird part about this is that the HSA assumes to get that full contribution maximum, you have to be covered by an HSA eligible plan for the entirety of twelve month year. So if you are only covered for part of the year, technically you do not get to make the full annual maximum contribution because you are not eligible for the entire year or covered for the entire year. Technically, you would have to prorate your maximum contribution based on the number of months in which you are actually eligible for that plan. So, for example, if you retire halfway through the calendar year, let's say at the end of June thirtieth, right? Like June 30 is your last day.
Technically, you were actually under that plan on the first of the month. The key here is you have to be on the first of the month for only six months. You got January, February, March, April, May, June, technically July 1, if you retire before then or separate from that plan before then, you would not be eligible, you know, for that July month, because July 1 would not be whenever you're under the plan. Therefore, you do not get to count that towards your proration. So technically, if think about six divided by 12, that's 50% just for simple math, you've got a basis on how many months you would be covered by your plan, but that means that you cannot contribute the maximum to your HSA in January of the year because you're covered at that time, you've got to look ahead and say, will I be covered the full year?
Okay, and then you get into the nuance of, well, what happens if I don't plan on stopping work and I actually didn't plan on retiring or didn't plan on getting laid off or whatever, and I planned on working the full twelve months, so I went ahead and maxed mine out early on in the year, and then I got my job change later, or I got out of the plan at some point in, let's say November, then what happens? Do I have to back out those contributions? What if I'm taking those from my W-two and I'm actually, you know, withholding those from my paycheck? How does that all work? So what I wanna do here is not necessarily belabor on how HSAs work.
You probably know that they are triple tax advantaged, you get to deduct it on the front end when you contribute that money to the account, it grows tax deferred, and then when taken out for qualifying medical expenses, you get to receive that money completely tax free as well. So it's triple tax advantage, it's also able to be invested along the way, it does not have to sit in cash. So in a perfect world, you're able to contribute to your HSA every year throughout your career, then you simply invest that money year after year, never use the money, and then when you get to retirement, you can use it for different things at that point in time as well, or you can actually on to your receipts, this kind of next level really fast, you can hold on to your medical receipts throughout your life and actually use those to offset distributions from your HSA in the future. Now, here's a little tidbit, I actually saw that there was a bill in Congress right now, they're trying to figure out if that is gonna remain in terms of like no timeframe on how long you have to wait before you can actually use old expenses to offset a distribution today.
Right now there's no cap or time limit on that, but I think that they're perhaps proposing a two year or twenty four month time limit, meaning you can't use expenses from beyond twenty four months ago to take a distribution out today tax free. Obviously, that's still a long way to go and we'll see what happens there, but just know that's on the radar. I did see something about that and I'd have to read more about it to know what's really in those terms or potential new rules. Right now, everything is as it has been and nothing has changed up to this point. Okay, so let's kind of shift gears and go from what HSAs are and how they work and the maximums, not really going to talk about that so much today.
What I want to give you is maybe three different scenarios, okay? Because what we've got here is especially around retirement, that's where things get a little bit muddy and depending on your age at retirement, it gets even muddier. So let's say this, let's say that right now you are on a non HSA eligible plan, and then halfway through the year you switch to an HSA eligible plan. So let's say you have an employer, they don't have an HSA option, you move jobs, and now your new employer does. Let's kind of run run with that scenario first.
What would happen is the question there is, hey Jacob, does the does the proration apply in that scenario where I've got no HSA for six months, and then I have an HSA for the last six months. Technically, there's a specific rule where you can actually make a full year's worth of HSA contribution, even though you were not under the HSA plan for that entire year, whenever you've switched into one. The key here is that you have to be on that HSA eligible plan on December 1 of the calendar year. So it's called the last month rule. Okay, so if you're eligible or enrolled in a health insurance plan that's HSA eligible and has that option, technically, if you're on that plan by December 1, you would fall under that last month rule and you would qualify for a full year's worth of contributions, not only based on the number of months you were on the plan.
Okay, so we'll go to the opposite of this in just a second in a different scenario, but I hope you're following me there on that. Now, the key requirement here is that you must remain on an HSA eligible plan for the following twelve months, so the following year. Okay, this is a testing period, so you can't jump on to a plan December 1 and then make a full year's worth of HSA and then do it again December 1 of the following year. That would be obviously going around the rules and skirting the rules in such a way that's beneficial for you, and that's why they have that twelve month testing period on there to basically assume that you are still active in that same plan or some other HSA eligible plan for that following twelve month period. Now, that's that's scenario one.
Okay, so if you're switching into an HSA plan mid year, guess what? If you're on that plan by December 1, you qualify for the entire year's worth of contribution maximum, assuming you are still on the plan for the next twelve months. If you're not on the plan for the next twelve months, that's whenever it gets kind of muddy. You'd have to start backing out contributions. If you left the plan before that twelve month testing period was over, I won't get into that right now in terms of the potential issues there, but just know that if you do it that way, try to make sure that you're on that plan for the rest of that twelve month time frame.
Okay. So that's the first scenario switching into a plan. Now, here's the one that probably applies to most of you who are thinking about retirement or getting close to it is whenever you switch out of an HSA plan mid year. And this is what my client is going through right now. So you're currently employed, let's say you have a retirement date of March 31 here in 2026.
So you're switching out of an HSA plan into whether it be Medicare, we'll get to that in just a second in the next scenario, or perhaps just a private ACA plan. So you're retiring and you're leaving your plan. This is probably where most people make the mistakes of overfunding. Okay, because under this scenario, if you start the year HSA eligible and switch to a non HSA plan, your contribution is going to be prorated as I mentioned earlier, and it's prorated based on the number of months in which you were covered by the plan as of the first of the month. Okay, there's no last month rule with this because you would obviously not be covered by that plan on December 1 if you retire on March 31.
So really in this scenario, following these kind of timelines, you've got three months out of 12 that you are covered under the plan. Therefore, if you do proration on this, 25% of the annual maximum is what you were able to contribute. Okay? So that is how you would prorate that based on a mid year retirement or a mid year job loss or a mid year, you know, leaving the plan. Now the problem here is really this, especially with those of you who are nearing retirement, you're probably making more money than you ever have, and you're like, hey, I'm trying to max this stuff out as much as I can heading into retirement before I can't, you know, contribute to an HSA plan anymore.
You're either auto maxing it out by having increased paycheck deductions early on, or you're just taking cash and dumping it straight into your HSA early and counting it good before you retire. So the problem there is you could over contribute, right? And then you've got to back out the extra contributions, but the key is, is you got to even know that this is a problem. You haven't even know that the rules work like this and that there is a proration involved here on partial year HSA eligibility. And so what you've done is if you're auto maxing by taking those contributions out of your paycheck, you know, you could reset your HSA contribution amount, which is one of my clients questions and say, hey, Jacob, should I, you know, go ahead and change my percentage of withholding for my HSA contributions to be where it maxes out over the three month period I'm about to work, and then I'm retired after March 31.
And that's a great thought, right? It's a good idea, but it's gonna cause over contribution. And so what you would maybe wanna do there in the last year of work, and I'll get to some ideas here in a moment as we close out. Maybe one of the ideas is just stop any of your paycheck contributions that you're auto withholding, stop those in the final year of work, if you know that you're gonna be stopping work or retiring mid year. The reason I say that is because whenever you have W-two withholdings and it's coming at being withheld out of your paycheck, let's say you did over contribute.
Well, how do you undo that over contribution? Do you go back to the employer? How do you do that with payroll? Like what it gets kind of messy and muddy really fast. So it's easier, especially in that last year of work, if you can make your contributions out of cash if you do want to make them.
Okay? And that way you can control exactly how much you contribute based on your projected work during that year and how long you would be eligible under that HSA covered plan, then you can dial that in perfectly. And then if you over contribute, guess what? It's easier for you to just take the over contribution out, rather than having to figure out with payroll and with HR and with your company or your former company, hey, how do I get this money correct? How do I get this out of my HSA?
Because you withheld it out of your out of payroll, I can't just take it out and refund it back to myself because I still got paid the money. And so do you take it back? And then how do we get that money to me in a paycheck? And so it gets really messy really fast if they're being withheld automatically from your paychecks. So that's just a thought on maybe what to do to minimize that risk here.
But the reason this is important is because if you have excess contributions, it could end up triggering, I think it's a 6% excise tax per year until you fix it. So if you over contribute, whether it be knowingly or unknowingly, you could be racking up this additional penalty or tax until that problem gets fixed. Okay? So this is where this is where most people fall. This is where most people fall because they're gonna retire most of the time, sometime throughout the year rather than exactly on December 31.
Some people obviously retire at the end of the year perfectly, but a lot of people retire mid year for various different reasons. So you've got to pay attention to, especially if you are maxing out an HSA every year, you've got to pay attention and understand how this proration works, some of the ramifications of it and the risks that are involved. And quite honestly, I think a lot of people have no idea that this is an issue. They just assume, hey, if I'm eligible for an HSA at the time of contribution, then I get to make the max. It's not true.
It doesn't work like an IRA contribution or something like that, where if you just have enough income throughout the year, you can make, you know, you can make a contribution based on that for the full year. Now, that's two different scenarios. The first one again was whenever we were transitioning into an HSA plan. The second one we just went through was transitioning out of an HSA plan. And the final one is transitioning from an HSA plan to Medicare.
And this is where it gets really just kind of hard and murky. If you enroll in Medicare exactly on your birthday at 65, okay, your HSA contributions work like normal in terms of the proration that I just went through, okay? Any eligible months, that's how much you can contribute to your HSA plan on a prorated basis. Okay, up to that maximum. The hard part is whenever you retire post 65 and you enroll for Medicare post 65, because there's technically a look back period on Medicare Part A when that would start.
And so here's an example that I would just like maybe put with you real quick and that way you can kind of get some context here. Let's say you're 67, okay, and you've worked, let's say it's June, you're 67 and you're turning on your social security at your full retirement age of 67. Just work with me here. Alright, if you did that, and you're still working, or you worked that six months, and you've been contributing to your HSA while you've worked that six months, but you're retiring in June, you're 67, you're also flipping on social security at the same time, and you've been covered by that HSA, you know, health insurance plan at work. Here's the issue.
Whenever you file for Social Security, Medicare Part A is automatically enrolled or triggered for you. You can't have Social Security without Medicare Part A. But here's the catch. Whenever you are enrolled in Medicare, you're no longer HSA eligible. And there's a six month look back period or retroactive period on Medicare Part A.
Okay, so it looks back over the last six months and says, if you enrolled in June, again in this example, for Medicare Part A by taking Social Security at your full retirement age, although you've worked the six months and you've contributed to your HSA for that six months, technically you've been HSA ineligible for those six months because there's that six month retroactive period on Medicare Part A regarding HSA eligibility, Okay, so any contributions made during that particular window of time under those circumstances I just outlined, they become excess contributions automatically. Okay, now the retroactive period is limited to either six months or back to 65, whichever is shorter. Okay, so for example, like if you retire at 65, and you do the proration thing perfectly on your HSA contributions up to that point, you retire mid year, you're not gonna be penalized for enrolling it for Medicare on your birthday at 65. You're not gonna have a retroactive period back to six months ago, which would create excess contributions, okay? It's age 65 or six months, whichever is less, whichever is shorter.
It's really for these this rule really makes a lot of difference for those of you post 65 retirement or working past 65, where you've got to pay a lot of attention. Okay, So that one there, scenario three, where you're on an HSA plan and then also triggering or enrolling in Medicare Part A, whether you know it or not, you could be over contributing to your HSA plan because as soon as you are on Medicare Part A, you're technically not HSA eligible anymore, and there's that six month look back period, or age 65, whichever is less. So all of these different reasons are why whenever you're thinking about retirement and looking ahead and planning on it, whether it be this month, twelve months from now, twenty four months from now, whatever your timeframe looks like, it's important to pay attention to these transition years because they deserve that much more attention. Because you could just be doing your thing where you're maxing out your HSA every year, doing what you think is right, and doing that's not wrong, it's just how you're doing it might end up causing issues or problems because of these transition years and how things kind of change over once you get to Medicare and 65 or 65 plus and when you decide to retire mid year or not.
So these types of things are hiding, they're just kind of sitting there waiting for you to mess up because you probably just don't know about it or don't know what to look for, and that's totally understandable. But that's why I wanted to bring attention to it today because this is something I'm walking through with a client right now. There's a lot of decisions to be made, and we can't really make the decision on whether or not he should or shouldn't contribute to the HSA at all right now, because we don't know what his health insurance looks like down the road. Because if he does COBRA, technically he's still on that same plan and would be eligible to contribute, right? COBRA maybe have higher costs, but he could still make the contribution up to the maximum for that year.
But if he goes through an ACA plan or a private insurance plan, he could have an HSA eligible plan in that scenario, which means that then he would still be able to make that whether it be under the last month rule or under the prorated amount of months that he does have coverage rule, either one would work there, but we have to know first before we make any contributions to his HSA or before we over contribute, what does the health insurance landscape for him and his family look like this year during a mid year retirement cycle and transition? So a few takeaways for you really quickly. Planning ahead obviously helps prevent a lot of these HSA mistakes that you had no idea were there. You can't just assume that the HSA limit applies to you every single year in full, it's got that proration, you know, thing on it. And understanding these rules is the first step, right?
You gotta even understand what to look for or know what to look for before just maxing out your HSA in the same year of retirement and you run into, oh my goodness, I over contributed without knowing it. And then you don't know until four years later when you get audited, and then they say, there's an excise tax on the over contribution that you've been racking up without knowing it too. So there's so many things that just continue to stockpile in the wrong direction if you don't know what to look for. And the final year of work, just remember this, the final year of work, that is what you have to pay attention to and requires extra caution and planning around your HSAs. So, hopefully this is insightful in some capacity.
Hopefully it gives you something to think about and just be aware of. If it was helpful, the first thing I'd ask you to do is please share it with a friend. That way they can learn from some of these same ideas as well. But then also, if you feel led and they're enjoying the content, I'd love a rating or review there on Apple Podcasts or Spotify wherever you listen. So, thanks so much for tuning in to this week's episode of Retirement Answers.
I look forward to talking with you again next week. Hey, it's Jacob again, and I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal, or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode. Look forward to talking with you again next week.