This article was written by Elaine Floyd, CFP® and modified from the original, found here.

A key feature of Medicare—and any insurance really—is that the system only works if people maintain continuous coverage. This is why anyone on Medicare—that is, anyone 65 or older and enrolled in Part A and/or Part B—also needs to have creditable drug coverage. If they go more than 63 days without creditable drug coverage after their initial enrollment period ends, they will pay a late enrollment penalty when they sign up for Part D. The penalty is 1% of the national base beneficiary premium ($34.70 in 2024) for every month they went without creditable drug coverage. This amounts to about 35 cents a month—not a huge amount but it could add up if there are many months—and it continues for life.

Most people avoid the penalty by enrolling in Part D at the same time they enroll in Parts A and B—that is, when they turn 65 or come off employer insurance if working past age 65. But there are some fairly common situations that can lead to the penalty without individuals even realizing it.

One of the most common situations is where an individual is working past age 65 and staying on an employer plan that pairs an HSA with a high-deductible health plan. The individual may know not to enroll in Medicare if they want to keep making HSA contributions, but they may not realize that the drug coverage offered by the HDHP is not creditable. When they finally go off the employer plan and enroll in Medicare, they learn that they must pay a Part D late-enrollment penalty because the entire time they were covered by the HDHP, they did not have creditable drug coverage.

Another common situation is where an employee retires and has retiree health insurance offered by the former employer. Anyone 65 or older who has retiree coverage must sign up for Medicare Parts A and B, because Medicare pays primary to retiree insurance. But they do not need to find supplemental insurance in the marketplace (Medigap or a Medicare Advantage plan) because the retiree insurance serves as the supplement—often including drug coverage. If the drug coverage is creditable, there’s no problem. But if the drug coverage offered by the retiree plan is not creditable, and if the individual later goes to sign up for Part D, penalties will apply. This could come as a surprise.

How is a person supposed to know if their drug coverage is creditable? And how are they supposed to know about the penalty in the first place? It’s probably safe to say that the vast majority of late enrollment penalties are not willfully incurred. People get hit with them because they didn’t know.

Note that the Part D late-enrollment penalty is separate and distinct from the Part B late-enrollment penalty. The Part B penalty is 10% of the premium for every 12-month period the person went without health insurance after qualifying for Medicare at 65. So it’s possible to be a few months late signing up for Part B and not be charged the penalty. But if a person goes more than 63 days without creditable drug coverage, the Part D late-enrollment penalty will apply.

What is creditable drug coverage?

Creditable drug coverage is at least as good as the coverage specified by Medicare’s standard drug plan design. Because the plan may not adhere exactly to the design—giving a little here, taking a little there—it just needs to be actuarially equivalent. As you can imagine, the formulas for determining actuarial equivalence are complicated and not something you can figure out for yourself. Rather, each insurance company is required to determine whether its plan meets CMS’s definition of creditable coverage and to disclose this information to employers.

Employers in turn are required to disclose this information to all Medicare-eligible employees. Medicare eligible policyholders include active employees, spouses, dependents, COBRA qualified beneficiaries, and retirees. Employers will not always know whether an individual is Medicare eligible, so it is recommended that they distribute the notice to all employees. Notification must be made: (a) annually, prior to October 15; (b) prior to the effective date of coverage for Part D eligible employees enrolling in the employer’s group health plan (e.g., new hire onboarding); (c) upon termination of the prescription drug plan; (d) if the creditable coverage status changes; and (e) upon request.

Because creditable drug coverage notification is not always obvious—it may be embedded in a newsletter or other routine communication—it is recommended that individuals request such information from their employers as part of the Medicare planning process. It should be noted that drug coverage offered by Tricare (for retired military), the VA, and FEHB (for retired federal employees) IS creditable. Individuals who have these plans do not need to sign up for Part D. Neither do individuals who are staying on employer or retiree plans that do offer creditable drug coverage.

Changes for 2025

The Inflation Reduction Act is ushering in some changes that may cause some plans whose drug coverage was previously creditable not to be so starting in 2025. In short, out-of-pocket spending by patients is being limited to $2,000 a year, with the difference largely being picked up by insurers. See this article for a more complete explanation of how this works. Insurers who do not meet this test—that is, who do not limit their insureds’ out-of-pocket spending to $2,000—will be deemed not creditable. That’s why this year, more than ever, all individuals 65 and older who do not have either a Part D drug plan or a Medicare Advantage plan that includes drug coverage—that is, individuals who are getting their drugs covered through an employer or retiree plan—will need to ensure that the coverage they have is creditable for 2025. If not, they will need to shop for and enroll in a Part D drug plan sometime between October 15 and December 7, with coverage starting January 1.

The mandate to disclose creditable drug coverage to Medicare-eligible individuals falls to the employer (who in turn gets the information from the insurer). Employers who fail to provide the necessary notifications risk violating their fiduciary duties under ERISA.