The IRS has released an information letter confirming that individuals are disqualified from establishing a health savings account (HSA) if their contributions are attributable entirely to a period when they are entitled to Medicare. The letter responds to an inquiry from an individual who had retired from his job and enrolled in Medicare before returning to work for the same employer. Upon rehire, the employee enrolled in the employer’s group health plan and was provided with an HSA. After learning that his Medicare enrollment made him ineligible for the HSA, he questioned whether he must pay a fine to the IRS for establishing an HSA and receiving employer contributions when he was ineligible to participate. The IRS’s letter confirms that the employee’s Medicare enrollment made him ineligible to contribute to an HSA, and consequently disqualified him from establishing an HSA. The letter directed the employee to withdraw the funds from the account and include them in his income, but explained that no fine would be due.

Comment: Medicare entitlement is automatic for some individuals (e.g., individuals who are receiving Social Security benefits)—they simultaneously become eligible, enrolled, and entitled. Other individuals must file an application to be entitled to benefits (e.g., working individuals beyond age 65 who are eligible to receive Social Security benefits but who have not applied for them). Employers rehiring retirees should be aware of these rules and avoid setting up HSAs for Medicare-entitled employees. Excess pre-tax contributions to a preexisting HSA caused by failing to recognize an employee’s ineligibility could trigger an additional 6% excise tax (in addition to ordinary income taxes) if the amounts are not timely distributed. No HSA excise tax would be due in a situation like the one in this letter, however, because when an individual who cannot make HSA contributions attempts to create an HSA, the HSA is simply disregarded for tax purposes. That situation—when there actually is no HSA—is one of the few situations in which an employer can ask a trustee or custodian to return employer contributions despite the usual nonforfeitability of HSA balances.