445 / Can participation in a health FSA impact an individual’s ability to contribute to an HSA?

GCM 201413005 states that carrying over FSA funds from year one to year two will prevent an individual from participating in a health savings account (HSA) in year two. HSA-eligible individuals must have qualifying high-deductible health plan (HDHP) coverage and no non-HDHP coverage other than permitted insurance, coverage providing only certain types of preventive care, or coverage with a deductible that equals or exceeds the statutory minimum annual HDHP deductible (collectively, HSA-compatible coverage). Unused amounts from a general-purpose health FSA that could be carried over to an HSA-compatible health FSA may be used during the general-purpose health FSA’s run-out period to reimburse expenses covered by the general-purpose health FSA that were incurred during the previous plan year.

A health FSA that reimburses all qualified Section 213(d) medical expenses without other restrictions is a health plan. Consequently, an individual who is covered by a general purpose health FSA that pays or reimburses qualified medical expenses is not an eligible individual for purposes of contributing to an HSA. This disqualification includes the entire plan year, even if the health FSA has paid or reimbursed all amounts prior to the end of the plan year. To prevent this, an individual may decline or waive a health FSA carryover in order to become eligible for the HSA, at least if the FSA plan permits.

A cafeteria plan may provide that if an individual participates in a general purpose health FSA that provides for a carryover of unused amounts, the individual may elect prior to the beginning of the following year to decline or waive the carryover for the following year. In that case, the individual who declines under the terms of the cafeteria plan may contribute to an HSA during the following year if the individual is otherwise eligible for the HSA.

However, if a cafeteria plan offers an HSA-compatible (limited purpose) health FSA, (i.e., one that covers, dental, vision, preventive care, and/or pharmaceutical expenses not covered under a health insurance plan) this does not prohibit funding an HSA. Thus, individuals wishing to participate in an HSA should either not carryover any FSA funds into the next plan year or make sure carryover funds are deposited in an HSA-compatible FSA (i.e., one that provides solely incidental benefits or reimburses other medical expenses after the deductible is met). There is no requirement that the unused amounts in the general purpose health FSA only be carried over to a general purpose health FSA. However, the carryover amounts may not be carried over to a non-health FSA or another type of cafeteria plan benefit.

Thus, if a carryover feature is included in the general-purpose health FSA plan, an employer has three options available to preserve employees’ HSA eligibility for the following plan year:

Option 1: Allow participants with a general-purpose health FSA to elect and enroll in a limited-purpose FSA — an FSA plan that is compatible with an HSA — for the following plan year. Those participants can carry over unused funds (up to the maximum limit) to a limited-purpose FSA; however, the carryover cannot be applied to another non-health FSA or another cafeteria plan benefit.

Option 2: Automatically enroll participants in a limited-purpose FSA if those participants enroll in a qualifying high deductible health plan (HDHP) and have a carryover balance in a general-purpose health FSA.

Option 3: Allow individuals to waive or decline a health FSA carryover prior to the beginning of the next plan year to become eligible.

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Planning Point: An employer may have both a general purpose health FSA and an HSA-compatible FSA. Where an employee participates in both and does not utilize all elected benefits in a year, GCM 201413005 provides an example for maximizing the benefits for the succeeding year while maintaining eligibility to participate in an HSA, as follows:

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Example: Employer offers a calendar year general purpose health FSA and a calendar year HSA-compatible health FSA. Both FSAs provide for a carryover of up to $500 of unused amounts and do not have a grace period. Employee has an unused amount of $600 in the general purpose health FSA on December 31 of Year 1. Prior to December 31 of Year 1, Employee elects $2,500 in the HSA-compatible health FSA for Year 2 and elects to have any carryover go to the HSA-compatible health FSA. Employee also elects coverage by an HDHP for Year 2. In January of Year 2, Employee incurs and submits a claim for $2,700 in dental care covered by the HSA-compatible health FSA. The plan timely reimburses $2,500, the amount elected. In February of Year 2, Employee submits and is reimbursed from the general purpose health FSA for $300 in medical expenses incurred prior to December 31 of Year 1. At the end of the run-out period, $300 in the general purpose health FSA is unused and carried over to the HSA-compatible health FSA. Employee is then reimbursed $200 for the excess of the January claim over the amount elected for the HSA-compatible health FSA. Employee has $100 remaining in the HSA-compatible health FSA to be used for expenses incurred in the year or carried over to the next year. Employee is allowed to contribute to an HSA as of January 1 of Year 2.