A Few Pesky HSA Compliance Issues

“[T]his young adult woman can open her own HSA. She doesn’t have to be the medical-plan subscriber. In fact, it’s not unusual for more than one person on a contract to be HSA-eligible.”

William G. (Bill) Stuart

Director of Strategy and Compliance

Dec. 13, 2018

One of the advantages of spending time in the field with benefits advisors, employers, and employees is that I’m asked a lot of compliance questions. It’s important for me to hear these questions since they help me gauge where HSA education is lacking. I then try to fill those knowledge gaps through my books, my blogs, my CE courses, and other media that I use to communicate with HSA stakeholders.

Here are several areas of continued confusion:

“Can an employee enroll in an FSA if he is enrolled in his employer plan that is non-HSA compliant, but his wife is on her own employer plan with their daughter and contributes to an HSA?”

The answer to this question is yes – and no. Let’s start with no.

A Health FSA falls under certain rules that pertain to a medical plan. Unless an employer restricts a Health FSA plan (I’ve never seen an employer place such restriction on a plan, but it’s legal to do so), a Health FSA automatically covers the participating employee, his spouse, his tax dependents, and his children to age 26.

This employee’s enrolling in a general Health FSA doesn’t disqualify him from anything. He’s already disqualified from opening and making or accepting contributions to an HSA because he didn’t enroll in an HSA-qualified medical plan.

His enrolling does affect his wife and daughter. They are now enrolled in two plans: her employer’s HSA-qualified medical plan and her husband’s general Health FSA. When someone has more than one coverage and wants to open and make or receive contributions to an HSA, all of her coverage must be HSA-qualified. Because she can receive first-dollar (no deductible) reimbursement from her husband’s Health FSA, she’s disqualified from participating in an HSA program.

She has no recourse. Her husband can’t disenroll from his employer’s general Health FSA (unless the plan year hasn’t started, or the plan year just began and the employer can attest to the Health FSA administrator that he enrolled in error).

He can’t terminate his Health FSA coverage by spending his balance quickly. He and his family members remain covered on the Health FSA until the end of the plan year (and perhaps longer if his employer has adopted a grace period or limited balance carry over).

She can’t simply not submit any claims or sign an affidavit pledging not to seek reimbursement from his Health FSA.

They can’t agree to reimburse only dental and vision expenses (the definition of a Limited-Purpose Health FSA, in which participation doesn’t disqualify someone covered by the plan from opening and making or receiving contributions to an HSA).

The moral of the story: As I explain in my CE classes, we’ve come to the point in our history in which benefits elections must become a topic of pillow talk between spouses. It’s sad but true. Prior to HSAs, one spouse’s benefit election didn’t restrict the benefits options available to the other spouse at her place of work.

If you’re interested in HSA eligibility and are married, you don’t live in that world. You must adjust.

By the way, the answer to the question is also yes. Yes, he can enroll in a non-HSA-qualified medical plan and participate in his employer’s general Health FSA. If his employer offers an HSA-qualified plan, he can enroll in it and still participate in a general Health FSA. It’s just that neither he nor any family members who otherwise are HSA-eligible can open and make or accept contributions to an HSA since the general Health FSA disqualifies them.

“I met with an employee who covered an adult child who’s no longer her tax dependent. I had to tell her that she can’t reimburse the daughter’s qualified expenses tax-free from her HSA. That’s one of the downsides of the HSA program.”

The broker who told me this was half right. I applaud him for understanding an important concept with which many people struggle. An HSA owner can’t reimburse certain family members’ qualified expenses tax-free, even if they’re enrolled on his HSA-qualified medical coverage. And can reimburse certain family members’ qualified expenses tax-free, even if they’re not enrolled on his medical plan.

Let’s roll the tape . . .

An HSA owner can reimburse her own, her spouse’s, and her tax dependents’ qualified expenses tax-free from her HSA. This role holds true regardless of whether these family members are HSA-eligible themselves or are enrolled on her medical coverage.

This example illustrates the opposite situation. The daughter is enrolled on her mother’s coverage, but the daughter is no longer her mother’s tax dependent. Thus, the mother can’t reimburse her daughter’s qualified expenses tax-free. Any distributions from the mother’s HSA for her daughter’s expenses are included in the mother’s taxable income. In addition, the mother is assessed a 20% additional penalty unless she has turned age 65 or is disabled.

So, my broker friend is correct.

What he didn’t understand is that this situation presents an opportunity for the family as well.

You see, this young adult woman can open her own HSA. She doesn’t have to be the medical-plan subscriber. In fact, it’s not unusual for more than one person on a contract to be HSA-eligible. In my family, for example, as I wrote in a recent post, three family members – my wife, my 24-year-old son, and me – are all eligible to open and make or receive contributions to an HSA.

Once she opens her HSA, anyone, including her mother, can contribute to that account. The young woman can then deduct those contributions when she files her personal income-tax return. That may not be the best news for her mother – who may be the source of the contribution and may face a higher marginal tax rate than her daughter, thus making the deduction more valuable to the mother than the daughter.

The daughter can then reimburse her own qualified expenses tax-free from the HSA.

The real opportunity here, other than the family’s enjoying tax-free distributions, is how much the daughter can contribute to her HSA. Let’s follow this reasoning:

  • The daughter is covered on a family contract. The statutory maximum annual contribution for family coverage in $6,900 in 2018 (and $7,000 in 2019).
  • Married couples can’t contribute in excess of the statutory contribution limit for a family contract.
  • The daughter isn’t married to anyone on the contract.

Given these facts, is it reasonable to conclude that both the mother and daughter can contribute up to $6,900 to their respective HSAs in 2018? An IRS official thought so when presented with a similar scenario (involving domestic partners, but the same principle seemingly applies to adjust non-tax-dependent children) at a meeting of a professional association in 2010. (Scroll down to No. 3 in this document. And many benefits attorneys and HSA providers agree. You may want to check with your legal or tax counsel to weigh the benefits and risks of this informal advice that can’t be relied upon as official IRS guidance.

By the way, you can learn more about this topic by reading our HSA Fact Sheet on Special Family Situations. This informational piece is one of more than a dozen HSA Fact Sheets that address very specific compliance topics in an easy-to-absorb question-and-answer format.

“My client needs to bridge the gap from early retirement to Medicare coverage. Can she use my HSA balances to pay premiums for this coverage?” (I think this should be My spouse, not My client.)

Generally, no. HSA owners can make tax-free distributions for qualified premiums. For pre-65 owners, the list of qualified premiums is limited to:

  • COBRA premiums
  • Non-group coverage when you’re collecting public unemployment benefits

Otherwise, withdrawals for premiums before an HSA owner turns age 65 are included in her taxable income and a 20% additional tax as a penalty unless she is disabled.

Given these limitations, it’s important for individuals to plan early retirement carefully. The thought of unshackling themselves from the daily responsibilities of work may create a compelling vision, but it must be balanced with financial reality. If you retire at age 63½ or later, you probably can continue your group plan by exercising your COBRA continuation rights.

In most cases, you can continue coverage for 18 months, which brings you to your Medicare Initial Enrollment Period (a seven-month period, beginning three months before the month of your 65th birthday, during which you can enroll in Medicare without penalty). And you probably want to do so. Group rates are typically blended so that all similarly situated employees (for example, family coverage) pay the same premium. Thus, young employees subsidize older employees’ premiums. In the nongroup market, your premium is higher because it’s based on your age.

It’s important to enroll in Medicare during the Initial Enrollment Period to avoid penalties. Although COBRA allows you to continue the group plan, COBRA isn’t considered group coverage. You may be subject to penalties if you defer Medicare enrollment when you’re first eligible. Also, you may have to wait until the next General Enrollment Period (the open-enrollment period prior to the July 1 anniversary date).

Be sure that you understand your coverage options and their financial implications as you plan for an early retirement.

What We’re Reading

It’s good to see that financial planners are realizing the value of HSAs as long-term accounts to build medical equity. In this article, a New Hampshire-based Certified Financial Planner provides excellent advice on HSAs and Medicare.

John Goodman, whose thoughts appear frequently in this column, explains how President Trump is radically reforming the Affordable Care Act by creating an environment in which companies can offer additional coverage options for Americans.

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