“An employer best practice is to run the medical plan and the Health FSA concurrently. That way, employees can review changes in cost-sharing in medical plan each year to make the appropriate health FSA election. They usually can’t open their Health FSA mid-year to alter their elections to reflect changes in their projected out-of-pocket costs.”
William G. (Bill) Stuart
Director of Strategy and Compliance
September 19, 2019
It’s almost that time of year again, when I have to deliver bad news to clients who want to implement a Health Savings Account program but have a Health FSA option that will disqualify the employees most likely to gravitate toward Health Savings Accounts.
In an effort to get ahead of these issues, I’m bringing up some relevant considerations now, when there may still be time to address the eligibility concerns.
Medical Plan and Health FSA Not Aligned
Example: Your medical plans runs on the calendar year, but the Health FSA is a July-to-June benefit.
Employees who want to open, make or receive contributions to a Health Savings Account can’t be enrolled in disqualifying coverage. A general Health FSA, because it offers first-dollar coverage for medical, prescription-drug, and over-the-counter services, is disqualifying coverage. Here are your options:
- Terminate the Health FSA effective December 31. Some employees will benefit (spent more than payroll deductions) and some won’t (more payroll deductions than reimbursement). With advance notice, employee forfeitures can be reduced, but that reduction is financed by the employer, who covers reimbursements without corresponding payroll deductions from January through June.
- Turn the general Health FSA into a Limited-Purpose Health FSA effective December 31. Payroll deductions continue, but reimbursements are limited to dental and vision only for dates of service beginning January 1.
- Do nothing. Employees enrolled in the general Health FSA can’t open, make or receive Health Savings Account contributions until July 1 (or later), when their Health FSA plan year terminates. Afterwords, employer and employee can begin to contribute (up to the statutory maximum, per the Last-Month Rule with its restrictions). This approach may reduce Health Savings Account enrollment in the first year among employees most likely to enroll, since they understand the immediate tax benefits of a Health Savings Account (identical to the Health FSA in which they’re enrolled). It’s best to run the Health FSA on a short (six-month) year to align renewal with the medical plan anniversary (January 1). Add a Limited-Purpose Health FSA January 1.
- Delay the Health Savings Account program until the following year. Employers can keep the current medical coverage, renew the general Health FSA on short (six-month) plan year, and then align the medical coverage and Health FSA January 1. Include a Limited-Purpose Health FSA option so that employees can maximize tax savings and enjoy instant access to funds for dental or vision expenses.
Your Medical Plan and Employee’s Spouse’s Health FSA Not Aligned
Example: Your medical plan runs renews January 1. One employee is enrolled in your coverage and their spouse participates in their employer’s general Health FSA that renews each April.
Sometimes the issue is that a spouse’s Health FSA doesn’t align with the plan year. An employee is automatically covered on a spouse’s Health FSA under federal tax law. In this case, the employer can’t do anything in benefit design to help this employee. But the company can share this document, which might help the family plan in the future. Spoiler: The spouse must not renew their participation in a general Health FSA, or the couple must divorce, before the employee can become HSA-eligible.
Health FSA with a Grace Period
Example: Your medical plan and general Health FSA renews January 1. You have adopted the grace period, which allows participants to continue to spend their balances during an additional 2 1/2-month extension of the Health FSA plan year.
Medical plan-Health FSA alignment is sometimes an issue, but not often. Situations are more common when two plans run on the same plan year, but the Health FSA has an extender – either a grace period or a balance carryover.
The grace period allows an unlimited rollover of funds into an extension of the plan year, up to an additional 2 1/2 months. In this case, the grace period overlaps with the new HSA-qualified medical plan. Employees who have any balance remaining as of January 1 aren’t HSA-eligible until the first day of the first month following the end of the grace period (or April 1 in this example). They can’t become HSA-eligible before then, even if they spend their remaining balance in January.
Fortunately, employees who want to open, make or receive contributions to Health Savings Accounts can take matters into their own hands. If they zero out (spend and receive reimbursement) their balances by the end of the 12-month plan year, they effectively forfeit their grace period. They can then open their Health Savings Account and begin to make and receive contributions immediately (assuming that they’re otherwise eligible).
Employers also have two options at their disposal. But they often use education to encourage employees to take the approach above and protect their Health Savings Account eligibility without affecting other employees. Here are the steps that employers can take:
- Eliminate the grace period prospectively. This a benefit take-away and can create some losers (such as the employee who was preserving their 2019 balance until the grace period, when they could pool it with their 2020 election to have vision-correction surgery on both eyes or undergo both dental implants at once).
- Turn the grace period into a Limited-Purpose Health FSA. The caveat here is that the employer can’t do so for only those employees enrolling in the Health Savings Account program. Because it’s an extension of the existing year, any change applies to all participants. This option is less drastic than eliminating the grace period, and it wouldn’t affect the people in the examples above – since they’re dental and vision patients – but it would limit anyone who wanted to use unspent balances to purchase medical services early the following year.
Carryover of Unused Funds
Example: You allow employees to carry over up to a $500 balance in their general Health FSAs into the following plan year.
The carryover provision is an alternative to the grace period. It’s more flexible because the funds carry over into a new plan year. But if this flexibility isn’t managed correctly, employees can lose their eligibility to open and make or receive Health Savings Account contributions for the full 12 months of the Health FSA plan year. That’s the bad news.
The good news is that employees and employer have more options to ease this transition. Employees can do the following:
- Spend their entire balance and zero out the account during the 12-month plan year. The carryover doesn’t apply because they don’t have any remaining balances to carry over.
- Refuse the carryover and forfeit the remaining balance. This option is available, but very unlikely in practice, since participants can simply exhaust their balances before the end of the plan year or rely on their employer to become HSA-eligible (below).
Employers can do the following:
- Prospectively terminate the carryover. Again, this option is theoretically possible, but unlikely because employers can . . .
- Carry over participant balances into a general or Limited-Purpose Health FSA on a participant-by-participant basis. Because funds are carried over to a new plan year (not an extension of the old plan year, as under the grace period), employers can treat each participant’s carryover balance differently.
As a General Rule . . .
An employer best practice is to run the medical plan and the Health FSA concurrently. That way, employees can review changes in cost-sharing in medical plan each year to make the appropriate health FSA election. They usually can’t open their Health FSA mid-year to alter their elections to reflect changes in their projected out-of-pocket costs.
It’s easy to run a Health FSA short year to align the two plans. Your Health FSA administrator should be able to tell you how to do so. If not, contract Benefit Strategies by clicking here or e-mailing firstname.lastname@example.org – we’ve helped many clients with this simple, clean change.
It’s Almost Never This Easy
Years ago, I had a client with a November 15 medical anniversary and a January 1 Health FSA plan year. The company planned to introduce a Health Savings Account program as a total replacement. I explained the compliance issues to the CEO.
He excused himself, opened the conference room door, and yelled, “Listen up. How many of you still have HSA balances?”
Two of the two dozen or so employees said they did.
“What are you planning to use the money for?” he asked. (He clearly hadn’t completed HIPAA training that year – or ever!)
I couldn’t hear the employees’ answers, but he came back into the room and said, “Dental. . . No problem. . . Let’s proceed.”
We converted the Health FSA prospectively to a Limited-Purpose Health FSA for all employees. Everyone became HSA-eligible December 1 (eligibility is determined as of the first day of the month). No participant lost any Health FSA balances as a result of the more restricted list of qualified expenses. And every employee who was HSA-eligible as of December 1 could open and HSA and make or receive contributions up to the statutory maximum for that year by leverage the Last-Month Rule.
You probably won’t be as lucky as that CEO (and I suggested that he play the lottery that week in case his positive karma extended beyond employee benefits). But your second-best position is to be aware of a potential issue and use the guide above to determine the best course of action for both employer and employees.
What We’re Reading
ICYMI, I wrote a guest blog explaining three reasons for increasing investment activity in Health Savings Accounts. Read my thoughts here.
A growing number of Americans are listing retirement medical costs as a major concern. But few are taking proactive steps, like contributing to a Health Savings Account or even discussing the topic with a financial advisor, to address the issue, according to a new study. Of course, people who’ve read my book, HSAs: The Tax-Perfect Retirement Account, already know this. But, believe it or not, not everyone planning for retirement had read it.