When an employer is implementing a Health Savings Account (HSA) qualified high deductible health plan (HDHP) for the first time, or when they offer it as one plan option among many, it is important for the plan participant to understand how other coverage can impact their HSA eligibility. This includes plans from the prior plan year that extend benefits into the new plan year, such as a standard Health Care Flexible Spending Accounts (HCFSAs) with either grace periods or rollover. In this article, we will be discussing what participants need to know when they are enrolling in an HSA qualified HDHP and previously had a standard Health Care FSA in the prior plan year.
In order to be eligible to make contributions (or receive contributions) to an HSA, a participant must (1) be enrolled in a HSA qualified HDHP, (2) not be another individual’s tax dependent, (3) not be entitled to Medicare, and (4) not be covered by any disqualifying coverage. In addition, eligibility to make HSA contributions is based on the status of the individual as of the 1st day of the month. If a participant makes (or receives) HSA contributions above what is permitted due to their eligibility, they will be subject to income tax and a 6% excise tax on the excess contribution.
Because standard HCFSAs reimburse participants for general medical expenses, they are classified as disqualifying coverage. If a participant is enrolled in a Limited-Purpose HCFSA, it would not be classified as disqualifying coverage, because reimbursement is restricted to dental and vision expenses.
It is important to keep in mind that participation in the standard HCFSA is disqualifying coverage for the entire plan year, regardless of when the participant exhausts their balance.
Impact of Standard Health Care FSA with Grace Period:
A standard Health Care FSA which offers a grace period provides participants an additional 2 ½ months in which they can incur claims after the end of a plan year. A HCFSA participant who has any funds left in their account on the last day of the plan year will trigger the grace period even if all of their expenses occurred before the grace period starts. During this 2 ½ month grace period, the standard HCFSA continues to be disqualifying coverage and participants are not eligible to contribute (or receive contributions) to an HSA, regardless of when their expenses were incurred or when their balance is exhausted. This means that the earliest that a participant can contribute to an HSA is the first of the month following the end of the grace period. (For calendar year plans, the first that a participant would be eligible to contribute would be April 1st.)
During the time in which a participant has disqualifying coverage, they may become ineligible to make contributions up to the full, annual IRS limit (for 2020: $3,550 for single coverage, $7,100 for family coverage). For a participant with single coverage who becomes HSA eligible on April 1, 2020, the maximum they can contribute is $2,662.50 ($5,325 for family coverage). Note: Under the full contribution rule, the participant would be eligible to contribute the full annual maximum based on their enrollment as of the first day of the last month of the taxable year (typically 12/1) provided they remain HSA eligible for that month plus the following 12 months after the end of the tax year (testing period).
Code § 223(c)(1)(B) allows certain coverages to be disregarded as disqualifying coverage. The grace period will not be disqualifying coverage to anyone that has a zero balance on the last day of the plan year. The zero balance is based on a cash basis. This means, that the claims have to have been submitted, processed, and paid, leaving a $0 balance in the account as of the last day of the plan year. Additionally, the grace period will not be disqualifying coverage if by plan design, the reimbursement of expenses incurred during the grace period is restricted to dental and vision expenses.
Example: For groups that have a Plan Year that runs from January 2019 – December2019:
If a participant has a $0 account balance as of 12/31/2019:
They can contribute to an HSA beginning 1/1/2020.
If a participant has a $0.01 account balance (or more) as of 12/31/2019:
They cannot contribute to an HSA until 4/1/2020.
What Can Brokers and Employers do to Assist Participants?
First and foremost, it is important to educate plan participants as to the rules related to making HSA contributions. It is important for them to understand that they must exhaust their Health Care FSA prior to the end of the plan year in order to be eligible for contributions into an HSA as of the first of a new plan year. This means that claims must be processed and paid, not just submitted to their claims administrator.
Employers can also consider alternatives in order to ensure as many of their plan participants remain HSA eligible as possible.
(1) Amend their FSA prior to the end of the plan year to remove the grace period from the standard HCFSA. (Grace period can remain on the Dependent Care FSA if applicable.) Keep in mind that some participants may be counting on the grace period where they will incur larger expenses where they will use funds from the prior year and funds from the current year to maximize their tax benefits. Removal of the grace period would not constitute a qualifying event where the participant can change their election, which may result in a forfeiture for the participant.
(2) Amend the FSA prior to the end of the plan year to convert the standard HCFSA to become the HSA compatible Limited HCFSA so reimbursements are restricted to dental and vision expenses.
(3) Amend their FSA prior to the end of the plan year to remove the grace period from the standard Health Care FSA and to add the rollover option. Note: Rollover does also pose issues to HSA eligibility. Please watch for an upcoming Compliance Buzz on this topic.
If this is the first time that an employer is offering an HSA eligible HDHP, they may also want to consider adding a limited purpose HCFSA in the new plan year, so employees can maximize their tax advantages.
What Should Participants Do?
Participants in a standard HCFSA with grace period should be mindful of their account balances. They should submit claims as early as possible to ensure they are processed and paid out of their accounts prior to the end of the plan year. If participants are unable to bring their account balance to zero prior to the end of the plan year, they should be aware that they would not be eligible to contribute or received contributions into their HSA until the first of the month after the grace period ends.
Participants should also be mindful that if their spouse has a standard HCFSA or a standard HCFSA with grace period, the same eligibility rules would apply as if it were their own.
What can Employee Benefits Corporation Do to Assist?
When an employer has both Employee Benefits Corporation’s BESTflex Health Care FSA as well as our SimplyHSA administration, Employee Benefits Corporation will watch for participants who are enrolled in the Health Care FSA (including grace period) who also establish a HSA. When this occurs, Employee Benefits Corporation will “pend” the HSA set-up until the participant is eligible for contributions into the HSA. This protects participants from making ineligible deposits, which could result in tax penalties.
Please review our other recent articles on other benefits that have an impact on HSA eligibility.
Medicare Enrollment's Impact on HSA Eligibility
Your Spouse's Health Care FSA's Impact on HSA Eligibility
Health Care FSA Rollover's Impact on HSA Eligibility