Special rules apply to people who contribute to tax-favored health savings accounts (HSAs) as they near age 65 and become eligible for Medicare.
A health savings account is an account that can only be used in conjunction with a health insurance plan that meets specific criteria, like a minimum deductible (at least $1,300 for an individual for 2016). It is used for medical costs that are not paid by the insurance plan, such as deductibles and copayments.
The money in an HSA account grows tax-free and it may be withdrawn tax-free, as long as it is spent on eligible medical expenses. Any balance in an HSA carries over year to year, and the account follows you if you leave your job.
Under current rules, once you enroll in Medicare you can no longer make new contributions to an HSA.
However, the HSA funds can be used to pay for Medicare Parts A, B and D premiums, deductibles and copayments; Medicare Advantage (Part C) premiums, copayments and coinsurance; dental and vision services; and even a portion of long term care insurance premiums. You can’t, however, use the funds for premiums for Medicare Supplement policies.
If your Medicare Part B and D premium is automatically deducted from your Social Security check, you simply reimburse yourself directly from your HSA for the Medicare premiums paid from your Social Security.
Once a person turns 65, their HSAs are no longer subject to the 20% non-eligible expense penalty. However, any withdrawal made for non-eligible medical expenses will be subject to ordinary income tax.