In part, due to the COVID-19 pandemic, some employers are exploring opportunities to allow employees to use their unused health flexible spending arrangements (“health FSAs”) funds from 2020. There are essentially two options for employers that want to allow employees to use their leftover FSA in the following plan year: (1) grace periods; and (2) carryovers. However, sponsors of high deductible health plans (“HDHPs”) should keep in mind how these two different rules interact with health savings accounts (“HSAs”).
Background
HSAs are tax-favored, IRA-type accounts that can be contributed to by, or on behalf of, “eligible individuals” who are covered by HDHPs. Because an HSA is a savings/IRA-type account, employees can accumulate dollars in the account and carry them over year after year. HSA funds may be used to pay for certain qualified medical expenses on a tax-free basis. However, to establish or contribute to an HSA, the individual cannot be covered under any other health plan that is not an HDHP.
By contrast, a health FSA is a tax favored account that reimburses qualified medical expenses and is a type of group health plan. Unlike HSA’s, FSA’s generally require employees to use all of the funds within the plan-year. There are two kinds of FSAs:
- Limited Purpose/Limited Scope FSA: These limited purpose health FSAs will only reimburse for permitted expenses (dental and vision, for example) or expenses after the HDHP deductible is reached and are HSA-compatible.
- General Purpose FSA: An FSA that reimburses for all health care expenses and therefore is not HSA-compatible.
An individual who is covered by a “general purpose” health FSA is not eligible to participate in an HSA because they have non-HDHP coverage. Because HSA eligibility is determined monthly, this restriction generally applies for any month the individual is covered by the health FSA and usually not just for the months when an individual has FSA money available for reimbursement. For example, Julio is in a general purpose FSA which is based on the calendar year (January through December) and does not have a grace period or carryover. However, Julio spends all of his FSA money by June. Julio will not become HSA-eligible in July. Instead, Julio may become eligible for an HSA in the following plan year if Julio enrolls in the HDHP.
What happens if Julio’s general purpose FSA instead has a grace period or a carryover into 2021?
