Can HSAs Help Bridge Coverage Gap for Early Retirees? Yes, but.
By William G. Stuart | Originally posted on LinkedIn for Health Savings Academy
You can't reimburse nongroup premiums tax-free from your Health Savings Account. But that's not the end of the story.
Talk about sticker shock! As more Americans build a nest egg to retire before age 65 to pursue passions, travel, or just exit the pressure of the corporate world for a leisurely retirement, many find that they forgot to consider one major budget line item: medical coverage. They can file for Social Security benefits as early as age 62, even though their full retirement age is 66 years and 10 months (born in 1959) or 67 years (born 1960 and later) to supplement retirement income from other sources.
However, there is no early enrollment option for Medicare. They can't enroll in the federal program for coverage of the elderly until they reach age 65. They're not required to purchase medical coverage at the federal level (though some states impose this mandate). They place a lifetime of accumulated assets at risk, however, if they choose not to protect themselves against a catastrophic loss like a heart attack, cancer, or liver failure. Thus, medical insurance is a financial necessity.
How to pay for coverage, particularly if you haven't budgeted this item? You can't (in most cases) pay nongroup premiums tax-free from your Health Savings Account. However, you can employ some strategies to reduce your net premium cost by strategic use of your Health Savings Account balances - particularly if you've been a diligent saver during your working and funding years.
COBRA Premiums
If you continue your group plan by exercising your rights under COBRA, you can pay those premiums with tax-free withdrawals from your Health Savings Account. The premium is expensive - typically 102% of the full premium. On the one hand, you'll experience sticker shock because your company (almost certainly) will no longer pay its portion of the premium. Imagine thinking you'll continue to pay your $150 monthly payroll deduction plus the 2% admin fee ($153), only to realize that your company paid 75% of your premium. Your full premium is $600 plus the 2% admin fee, or $612 monthly.
On the other hand, you're most likely paying a bargain price for coverage. Most companies set fixed employee premiums for all workers on the same product with the same contract tier (for example, self-only, employee+spouse, or family). In other words, a 25-year-old and you - at least three decades older) each pay, in our example above $150 per month in payroll deductions for medical premiums, even though older workers on average incur much higher claims.
If, instead of opting for COBRA, you chose a plan in the nongroup market (through a federal- or state-facilitated marketplace, a private marketplace, or an insurer), your premium would reflect your age. You may pay a much higher premium than your COBRA price, even if you chose a plan with higher cost sharing. On the other hand, you may qualify for advance-premium tax credits (premium subsidies) that reduce your net cost of coverage. It's worth exploring all your options before you make a final decision.
COBRA is often the better option - particularly if you’re retiring early through diligent saving through high lifetime income and therefore don’t qualify for taxpayer-funded premium subsidies. COBRA, however, has an expiration date. Usually, your period of coverage doesn't extend beyond 18 months. Thus, unless you retire at age 63 1/3, COBRA continuation won't bridge the full gap to age 65, when you're eligible to enroll in Medicare. Thus, absent other coverage options (such as jumping on a spouse's plan, if you're planning to retire and have your spouse continue to toil in the 9-to-5 world), you'll have to purchase a nongroup plan to cover the span between the end of COBRA and the beginning of Medicare coverage. Those nongroup premiums are not qualified for tax-free reimbursement (except in the situation below).