An internal IRS memorandum has provided much-needed clarification on the interaction between the new $500 carryover rule for health FSA plans and eligibility to make contributions to a health savings account (HSA). The conclusions in the memo are generally favorable, but employers wanting to both offer the carryover rule in a health FSA and allow employees to be HSA-eligible will need to carefully design their health FSA plans to take advantage.
Background. In guidance issued last year, the IRS provided limited relief from the use-it-or-lose-it rule that applies to health FSA plans by allowing for a carryover of up to $500 of unused amounts each year. (See my post here.) Among the open questions was how this carryover would affect an individual's eligibility to make HSA contributions and what steps, if any, could be taken to ensure an individual would be HSA-eligible if the individual had a carryover amount. In general, to be HSA-eligible, an individual cannot have any low-deductible health coverage, including coverage under a general-purpose health FSA.
Carryover Affects HSA Eligibility for Entire Year. In this recent memorandum, the IRS confirmed that an individual who has a carryover amount in a general-purpose health FSA is ineligible to contribute to an HSA for the entire carryover year, even after the individual exhausts the balance in the health FSA. For example, if at the end of 2014 an individual has $400 remaining in a general-purpose health FSA and that amount carries over to a general purpose health FSA for 2015, the individual will not be eligible to contribute to an HSA for all of 2015, even if the individual obtains reimbursement of the full $400 in January 2015.
Options. But the IRS also outlined some options for managing the carryover in a way that will allow the individual to remain HSA-eligible in the carryover year.
(1) Elective Carryover to HSA-Compatible FSA. Certain health FSA plans will, by design, allow an individual to remain HSA-eligible. For example, a limited-purpose health FSA that only reimburses dental, vision, and preventive-care expenses is permissible. So is a health FSA that only provides reimbursement after the individual has met their deductible under the associated high-deductible health plan (HDHP). The IRS has confirmed that an individual with a carryover amount in a general-purpose health FSA may elect, prior to the beginning of the plan year, to have that amount carried over to an HSA-compatible health FSA. That individual will then ben HSA-eligible for the entire plan year (assuming all other eligibility requirements are satisfied).
(2) Automatic Carryover to HSA-Compatible FSA. A health FSA plan may also provide that an individual who elects HDHP coverage for a plan year will be automatically enrolled in an HSA-compatible health FSA and any carryover amount will automatically carryover to the HSA-compatible health FSA.
(3) Election to Decline Carryover. A health FSA plan may give an individual an election, prior to the beginning of the plan year, to decline any carryover that might otherwise apply. (The declined carryover amounts would be forfeited.) The individual would then be HSA-eligible for the entire carryover year.
Relationship to Runout Period. The IRS's memorandum also clarified that an individual who is carrying over an amount from a general-purpose health FSA to an HSA-compatible health FSA can continue to obtain reimbursement during the runout period of general expenses incurred before the end of the prior plan year. For example, assume an individual has a $600 balance remaining in a general-purpose health FSA on December 31, 2014. The individual elects to have any carryover credited to a limited-purpose health FSA for 2015 and also elects to contribute $1,000 to the limited-purpose health FSA for 2015. The individual incurs $1,100 in dental expenses during January 2015 and is immediately reimbursed for $1,000 of those expenses. In February 2015 (during the runout period for 2014), the individual submits a claim for reimbursement of $200 of medical expenses incurred in 2014 and is reimbursed out of the $600 balance remaining at the end of 2014. At the end of the runout period for 2014, the $400 balance remaining for 2014 carries over to the limited-purpose health FSA for 2015, and the individual obtains reimbursement of the remaining $100 in dental expenses incurred in January 2015. And all is right and good in the world.
The IRS's memorandum outlining these principles is here.
Want to learn more about HSAs, HDHPs, and other options for consumer-driven health care? I'll be presenting a half-day seminar on consumer-driven health care in New York, NY on April 30 and Minneapolis, MN on May 21. For information, see here.