What is the maximum that an individual can contribute to a health savings account (HSA) when he/she becomes HSA eligible after the start of the calendar year due to a prior-year-end FSA balance on a plan with grace period or rollover?
For any standard health FSA (Grace Period or Rollover): An employee with a $0 balance as of the end of the plan year is eligible to contribute to an HSA on the first of the following plan year.
For standard health FSA with Grace Period: An employee who participated in a standard health FSA in the prior year (and had an account balance on the last day of the plan) is eligible to open an HSA the first of the month following the end of the grace period, which is 4/1 for a calendar year cafeteria plan.
For standard health FSA with Rollover: An employee who participated in a standard health FSA in the prior year (and had an account balance on the last day of the plan) is eligible to open an HSA the first of the month following the runout period (4/1) PROVIDED THAT the FSA balance is completely exhausted during the runout period with all claims filed during the runout period having been for expenses in the prior plan year.
Note: If all rollover claims are not processed during the runout period, or if some of the claims processed were for the current plan year, the employee would not be eligible to establish an HSA as of 4/1. The rollover would further delay HSA eligibility until the start of the next plan year (or beyond that if funds remain). Employers can help employees with HSA eligibility issues by adopting any of the HSA compatible plan provisions we have available as part of their cafeteria plan (i.e. auto convert, minimum balance to rollover, participation in the FSA required in the new plan year to be eligible for rollover).
Full Contribution Rule
If an individual has HSA qualifying coverage on December 1 of any year, they may take advantage of the Full Contribution Rule. This Rule allows the individual to contribute based on the coverage plan type in effect on December 1 (single or family).
In order to do this, the individual must remain eligible to make HSA contributions for the next 12 month period (1/1 through 12/31), which means they must maintain a qualifying HDHP and have no other disqualifying coverage for that entire calendar year. This does not mean that they are required to maintain family HSA qualified HDHP coverage for that next calendar year. They could move down to single HSA qualified HDHP for the following year and still meet the qualifications.
If they do not satisfy the 13 month (example - 12/1/2019 through 12/31/2020) testing period, their contribution reverts back to the prorated maximum contribution permitted for the previous year and any additional contributions are considered “ineligible contributions.”
If the employee fails to remain HSA eligible for the entire 13-month testing period, the ineligible HSA contributions will be subject to a 10% excise tax (in addition to regular income tax).
Note: In this scenario, the HSA contributions would be considered ineligible contributions, so the 6% excise tax and the ability to safely remove excess contributions prior to the tax filing deadline would not apply. Even if the ineligible contributions were removed, the 10% excise tax would still apply (in addition to regular income tax) in addition to an ineligible distribution penalty for the amount removed.
- Example 1: Assume Joe, who became eligible on April 1, 2019 and elects to make the full contribution for single plan ($3,500) for 2019, even though he only participates 9 months in 2019. If he does not remain HSA eligible for the entire 13-month (December of the current year through December of the following year) testing period, the excess contributions (those in excess of $3,500 x (9/12) = $2,625, which represents 9/12 of the annual maximum for single coverage for 2019) are considered “ineligible contributions” and will be subject to a 10% excise tax penalty plus regular income tax.
- Example 2: Assume Joe, who became eligible on April 1, 2019, elects to be conservative and only contributes $3,500 x (9/12) = $2,625. He does not remain HSA eligible for the entire 13-month (December of the current year through December of the following year) testing period, and during open enrollment for January 1, 2020 he elects to switch health plans and enrolls in coverage that is not an HSA qualified HDHP. Because Joe did not take advantage of the full contribution rule and only contributed the prorated maximum, he does not have any ineligible contributions for the 2019 plan year and will not have any tax penalties.
The Bottom Line: An employee, who becomes HSA eligible after the start of the calendar year, can take advantage of the full contribution rule and fully fund the HSA based upon the coverage they have on December 1st of that calendar year. Employees that take advantage of this rule, however, must remain HSA eligible for the entire testing period or will face excise tax penalties in addition to income taxes. Participants should always consult a tax advisor for advice regarding how to best handle the matter and to understand any tax implications.