FAQ: An employee became Medicare eligible in July, but continued to make pre-tax HSA deferrals and receive employer HSA contributions. How should this situation be addressed?

First, please note that simply turning age 65 does not make an individual ineligible for HSA contributions. The person only becomes HSA ineligible if he becomes entitled to (that is to say, enrolled in) Medicare. Enrollment in Medicare is not automatic for someone who turns 65, unless they start receiving Social Security.

If the employee actually enrolled in Medicare in July upon attainment of age 65, his Medicare would be considered impermissible coverage that would make him HSA-ineligible. Medicare is disqualifying coverage because it allows for cost sharing for medical expenses (other than preventive care) before the HDHP deductible is satisfied. In this situation, the employee would only be eligible to contribute for the first six months of the year. For self-only coverage, the 2019 annual HSA contribution maximum ($3,500) and 55 and older catch-up amount ($1,000) would need to be prorated; the result would be a 2019 maximum contribution of ($4500 x 6/12) or $2,250. So, the employee’s maximum 2019 contribution would be $2,250, and any funds contributed above this amount would be an excess contribution.

With respect to the employer contribution, it is important to keep in mind that HSA contributions are generally non-forfeitable. This situation does not fit the very limited exceptions for an employer’s recoupment of excess contributions, which are if the employee was never HSA eligible or the employer contributed beyond the statutory maximum ($4,500 for 2019). Nor is this a case in which there was a clear process error (for example, the contribution was credited to the wrong employee).

So, the employer would not be able to recoup the employer contributions. IRS Notice 2008-59, Question 25, makes it clear that the excess contribution cannot be returned to the employer in this type of situation:

Example. Employee N was an eligible individual on January 1, 2008. On April 1, 2008, Employee N is no longer an eligible individual because Employee N’s spouse enrolled in a general purpose health FSA that covers all family members. Employee N first realizes that he is no longer eligible on July 17, 2008, at which time Employee N informs Employer O to cease HSA contributions.

Employer O’s contributions into Employee N’s HSA between April 1, 2008 and July 17, 2008 cannot be recouped by Employer O because Employee N has a nonforfeitable interest in his HSA. Employee N is responsible for determining if the contributions exceed the maximum annual contribution limit in § 223(b), and for withdrawing the excess contribution and the income attributable to the excess contribution and including both in gross income.

To correct the excess contributions, the employee would need to remove the excess from the account by completing the appropriate form provided by the HSA custodian. Provided that the correction is made prior to the employee’s 2019 tax filing deadline (April 15, 2020, or later, if he files for an extension), the employee would not be subject to a penalty tax. If the excess contribution is not included in Box 1 of Form W-2, the employee would report the excess amount as other income on his individual return.

The employee must also remove any earnings on the excess amount while in the HSA. The earnings typically are the interest earned. However, if the funds were invested (as in stocks or mutual funds), the earnings would be the appreciation in value. The employee will owe taxes on the earnings and will need to include this amount as other income on his income tax return in the year of withdrawal. Although the amount is normally small, the IRS has a special rule for calculating the earnings.

If the excess contribution is not removed prior to the employee’s tax filing deadline, then the employee would need to file an IRS Form 5329 to pay the 6% penalty tax, but would not need to remove the earnings. Of course, the employee should consult with his tax advisor regarding any tax questions related to the excess contribution and reporting. IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, may also be helpful.

IRS Publication 969 »