Potentially the most frequent compliance question for employers with existing or new HDHP plans is the interaction between Health FSAs and HSAs in terms of participant eligibility and elections. In addition to coverage under a HDHP, in order to be eligible to make HSA contributions a participant also must not have disqualifying coverage under another health plan. Generally, Health FSA coverage is disqualifying coverage. However, employers offering HDHP plan options can still utilize the Health FSA if the plan is structured properly. For example, an employer that offers HDHP coverage as one of multiple health plan options can sponsor a general purpose FSA for employees that choose non-HDHP coverage or employees that elect the HDHP coverage but do not open an HSA bank account. In addition, limited purpose Health FSAs designed to reimburse only dental or vision expenses are not considered disqualifying coverage.
Consideration #1: HSA Contributions Can Be Made (Pre-Tax) Through A Flex Plan
This is the easy part. If a company implements a High Deductible Health Plan (“HDHP”) and HSA bank account option, the flex plan can be amended to allow participants to make HSA contributions on a pre-tax basis. Thus, HSAs may be funded with employee pre-tax salary reductions (or benefit credits) in addition to employer contributions. In fact, if an employee is a participant in an HSA, any pre-tax contributions to the HSA would have to be through a flex plan. Any contributions not made through the flex plan would be post-tax.
If a company has an adopted an HSA option and intends for employees to be able to make pre-tax contributions through a flex plan, the flex plan documents should be amended to show the HSA as an applicable benefit option. Also, a consideration for employers is that any HSA contributions will be included in the flex plan nondiscrimination testing. If Key Employees will be contributing to the HSA on a disproportionate basis, the presence of HSA contributions in the flex plan could affect testing results.
Consideration #2: Employees With General-Purpose Health FSAs May Not Participate in an HSA
IRS regulations are very strict about qualifying requirements for HSA eligibility. One requirement is that no individual eligible for an HSA bank account can be covered by any benefit which provides first-dollar coverage for medical expenses (i.e. copays, prescriptions, or other medical expenses). Accordingly, IRS regulations mandate that an employee who is covered under a general-purpose FSA does not qualify as an eligible individual for purposes of HSA coverage. Any individual participating in both an HSA plan and Health FSA plan would jeopardize his/her tax-favored status in both plans. A participant with a $0 year-end FSA balance, who is otherwise HSA eligible, will be eligible for HSA contributions immediately after the FSA plan year ends. However, a participant with a year-end balance under a general-purpose FSA with the grace period or rollover option may be ineligible for HSA contributions until the end of the grace period or rollover period. Contact us for more details on these scenarios.
Many employers continue to offer the full Health FSA even if they implement an HSA option. This option is valuable for employers who offer multiple health coverage options (i.e. low deductible PPO plan and high deductible plan with HSA). The FSA option also assists individuals who seek more immediate coverage (especially in the short term, since HSA is “pay as you go” rather than an annualized benefit). There is no requirement that an individual be in a HSA if the employer makes it an option for a particular HDHP plan. FSAs also assist employees who are ineligible for an HSA plan due to spouse’s coverage.
Consideration #3: Employees with HSAs Coverage May Also Have a Limited Purpose Health FSA
For employees who have an HSA bank account, there is an option to seek additional tax savings benefits for certain categories of expenses through a Health FSA without compromising HSA eligibility. If a Health FSA is limited to cover only dental and vision expenses, then an employee may participate in the FSA (known as a “Limited Purpose FSA” or “Limited FSA”). The Limited FSA may not be designed to cover any general medical expenses eligible for reimbursement under the HSA.
For the Limited FSA to be an option, the plan documents must allow for a Limited Purpose FSA, and the employee must elect the Limited Purpose FSA option and make an annual election just as he/she would for a general purpose Health FSA. This solution is common, and is supported and administered by ProBenefits for clients who would like to offer FSA benefits to those employees who have elected an HSA. Standard documents provided by ProBenefits to FSA clients include this option. An FSA plan can offer both general purpose FSAs and Limited FSAs. There is no requirement that all employees have the same type FSA.
Consideration #4: Additional Option – Specific FSA Election To Protect HSA Eligibility
For individuals who have a spouse or dependent(s) eligible for HSA coverage through another employer plan or individual plan, alternative election options are available to allow the employee to continue Health FSA participation and protect spouse or dependent HSA eligibility. As with the Limited FSA option, for these options to be available, the options must be included in the plan documents and the corresponding election must be made by the participant. Standard legal documents provided by ProBenefits to its FSA plan clients include these options.
Sample alternative elections to protect HSA eligibility:
- Option for participant election of an Employee-Only FSA, where such election is needed to protect the eligibility of the participant’s spouse and/or children for an HSA, and allow employee to participate fully in an FSA;
- Option for participant election of Employee-Plus-Children FSA, where such election is needed to protect the eligibility of the participant’s spouse for an HSA, and allow employee and children to participate fully in an FSA.
Consideration #5: Additional Option – Post-Deductible FSA
A rarely used FSA option for employers to use in conjunction with an HSA is a Post-Deductible FSA. A Post- Deductible FSA can reimburse eligible medical expenses, but only after an individual has met the minimum annual deductible for HSA eligibility. Only expenses incurred after meeting the deductible would be eligible. Example: John Jones has a HDHP ($2,500 deductible) plan through his employer, and participates in an HSA. If John’s company had a Post-Deductible FSA, John would be eligible to be reimbursed from the FSA for eligible expenses incurred after he satisfied and documented that the HSA minimum deductible ($1,350 for 2019) was met.
Because of the restrictions as well as the unlikelihood of employee participation in such a plan, Post-Deductible FSAs are rarely used.
Consideration #6: Difficulty of Implementing HSA Mid-Year
Without question, introducing an HSA option in the middle of a flex plan year is problematic. Employees already participating in the employer’s general purpose Health FSA would be ineligible for HSA contributions until the end of the flex plan year (or potentially longer if a grace period or rollover option is offered with the FSA and the employee has a positive balance at year-end). The employer would have certain options, including: (1) offering HSA only to employees not participating in the FSA; (2) terminating FSA mid-year for all participants; or (3) converting general purpose FSAs into Limited FSAs for the duration of the plan year. Unfortunately, each of these options entails distinct disadvantages. Before implementing an HSA plan mid-year, make sure to examine all applicable rules and restrictions in order to ensure that the participants are not adversely affected by the timing of the implementation.
As this document indicates, coordination of benefits issues related to HSA participation can be complex. If your company has implemented or is considering implementing an HSA option, contact your benefits advisor or our team for further details. We will attempt in every case to provide as much guidance and assistance as we are able, but the nature of these issues is such that a company should fully research and analyze all legal and tax implications of the proposed plan design prior to implementation.