Compliance Trap: HSA & FSA – When There Is a Grace Period Or Carryover

Despite an employer’s best intentions, many entities do not have processes in place to ensure that they are compliant with the IRS’s health savings account (HSA) rules. Others are not even aware of the compliance risks and find themselves in violation, which creates risks for both the company and their employees.

There are four main HSA compliance “traps” that fall into 4 main categories:

  • Disqualifying Coverage – eligibility violations
  • Contribution issues – excess or ineligible contributions, failure to open an account
  • Cafeteria Plan Issues
  • Mistaken Contributions

This is the second blog post on disqualifying coverage. As mentioned previously, a health flexible spending arrangement (FSA) or a spouse’s FSA (unless it is limited purpose or post-deductible) is problematic.

However, employers who offer a health FSA also need to understand the complications if they also offer an HSA. Especially employers who have a calendar year FSA and their medical plan renews off calendar year. Or employers who add an HDHP when they already have a health FSA established. Their health FSA plan design may impact HSA eligibility, preventing employees from being eligible to participate in an HSA when they first enroll in a HSA compatible high deductible health plan (HDHP).

Grace Period

For instance, a grace period is an optional plan design feature that permits participants with unused amounts at the end of the plan year to continue incurring reimbursable claims from that unused balance for up to 2 ½* months following the end of the plan year. This plan design disqualifies an individual from HSA eligibility unless they have a zero balance on the last day of plan year.

A zero balance means the claims have been processed and the account balance shows $0.00. If they have any amount in their FSA as of the last date of the plan year, they are not eligible to contribute (or receive contributions) to an HSA until first of the month following the end of the grace period. Even if they spend the remaining money during the grace period.

EXAMPLE:

  • Kelsey is a full-time employee at Jam Studios. For 2020, Kelsey is enrolled in a PPO plan and contributes $2,750 to the calendar year health FSA with a 2 ½ month grace period.
  • Jam Studios for 2021 open enrollment adds an HDHP plan with a $100/month employer HSA contribution.
  • Kelsey decides the HDHP is a better option for her and elects this new plan option in November at open enrollment effective for the 1/1/2021 plan year.
  • On December 31, 2020, Kelsey’s health FSA account had a $300 balance remaining. Kelsey is not eligible to open an HSA, make or receive any HSA contributions until the first of the month after the 2 ½ month grace period, or 4/1/2021. Even if Kelsey submits a claim for reimbursement during the grace period.

Carryover

Likewise, a carryover is an optional plan feature that permits health FSA participants to carryover up to $550 (2020 maximum*) of unused amounts the subsequent plan year. This may also create a problem.

Solutions

There are ways for the health FSA plan to be designed to avoid these hiccups. For instance, a plan with a:

  • Grace Period or Carryover: Plans could be designed to permit participants to opt out or waive the grace period or carryover prior to the beginning of the following year.
  • Carryover: Plans with a carryover could be designed so a minimum threshold amount is required to create a new annual election and if the employee’s balance is less than the minimum their health FSA participation does not automatically continue.
  • Carryover: The employer with a carryover could offer a limited purpose FSA and design their plan so remaining funds automatically carry over to the limited purpose FSA for employees who elect an HDHP.

But these plan design options need to be made prior to the start of the plan year.** Therefore, employers need to be aware of these traps in order to educate their employees prior to being permitted to enroll in an employer’s HSA.

*The grace period timeframe and carryover limits mentioned are under generally applicable FSA rules. Because of the COVID-19 pandemic and unanticipated changes in the availability of certain medical care, the IRS recognized employees may be more likely to have unused health FSA amounts at the end of plan years, or grace periods, ending in 2020. Notice 2020-29 provides temporary special rules that allowed employers to amend their cafeteria plans to extend the period employees could be permitted to use health FSA amounts remaining in their accounts as of the end of the grace period or plan year. However, an individual is not eligible to make contributions to an HSA during a month in which the individual participates in a general purpose health FSA to which unused amounts are carried over or the grace period is extended.

**The IRS made exceptions for plan amendment rules due to the pandemic. Employers may amend their plans to allow employees, on an employee-by-employee basis, to opt out of the carryover or to opt out of any extended period for incurring claims in plan years ending in 2021 and 2022, to preserve their HSA eligibility.

This is Part 2 of HSA Compliance Traps. Be sure to follow our blog to learn about the additional HSA Compliance Traps published later this year.

If you have a question, we are here to help! Let us end your employee benefits compliance confusion. Send us an email today!

The Compliance Rundown is not a law firm and cannot dispense legal advice. Anything contained in this post or on our website is not and should not be construed as legal advice. If you need legal advice, please contact your legal counsel.

Health savings account (HSA) eligibility is often misunderstood

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IRS Publication 969 outlines the rules for one to be eligible for an HSA. To be eligible one must:

  1. Be covered under a high deductible health plan (HDHP), on the first day of the month.
  2. Have no other health coverage except what is permitted under “Other health coverage” (also defined in the publication)
  3. Not be enrolled in Medicare.
  4. Not be claimed as a dependent on someone else’s tax return.

Of these four eligibility rules, there is often confusion around item #2. Many do not connect “other health coverage” with health FSAs/HRAs.

Employees enrolling in their employer’s general purpose (i.e. can be used for medical expenses) health FSA or HRA or an employee’s spouse being enrolled in their employer’s health FSA, generally disqualifies an employee from making or receiving HSA contributions for the entire plan year.

Likewise, if there are funds left in an employee’s health FSA at the end of the FSA plan year and there is a:

  • grace period (i.e. up to an additional 2 ½ month period after the FSA plan year ends when expenses may be incurred) an employee is not eligible to make or receive HSA contributions until the first of the month after the grace period is over.
  • carryover provision (i.e. permitting up to $500 of the unspent FSA balance to be used in the next plan year) an employee will be ineligible to make or receive HSA contributions for the entire plan year.

There are ways for a health FSA or HRA to be designed (e.g. post-deductible or limited-purpose) so it’s compatible with an HSA and there are also ways for employers to ensure employees don’t lose HSA eligibility for the following year (e.g. if FSA has a carryover provision and an employee elects an HDHP, the balance automatically transfers into a limited purpose FSA), so it’s important to work with your benefits consultant and FSA administrator to ensure employer-provided benefits don’t become “gotcha’s” for your employees.

FSA – Grace Period vs. Run Out Period

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FSA plan year = 12 month period expenses may be incurred

Grace period = up to an additional 2 ½ month period after the FSA plan year ends when expenses may be incurred, as determined by the plan administrator (i.e. employer)

Run-Out period = time frame after the plan year and/or grace period has ended to submit claims for expenses incurred during the plan year and/or grace period (depending on plan design & determined by plan administrator)

Some plans are set up to have two run-out periods, one that starts at the end of the FSA plan year and a 2nd one that starts at the end of the grace period.

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Not all TPAs systems will accommodate this, rather they only allow the run-out period to start at the end of the FSA plan year. Therefore, if you want employees to have time to submit claims after the grace period ends for expenses incurred during the grace period, you must ensure the run-out period time frame is longer than the grace period.

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