QUESTION: We are thinking of amending our company’s calendar-year cafeteria plan to add a grace period. However, we have heard that a grace period under our general-purpose health FSA might adversely affect our employees who want to discontinue their health FSA coverage and make HSA contributions. Is this correct?
ANSWER: A health FSA grace period can adversely affect employees’ (and other individuals’) eligibility for HSA contributions. As background, employees who are covered under a general-purpose health FSA (i.e., a health FSA that reimburses all eligible Code § 213(d) medical expenses) are not eligible for HSA contributions. That’s because a general-purpose health FSA imposes no deductible, is not limited to preventive care, and is neither “permitted insurance” nor “permitted coverage” under the HSA rules. If a general-purpose health FSA has a grace period, employees who are covered under the health FSA on the last day of the plan year and thus are entitled to the grace period will continue to have their disqualifying coverage under the health FSA for the grace period’s duration. These employees are ineligible for HSA contributions until the first calendar month after the grace period ends (e.g., April 2019, in the case of a January 1, 2019—March 15, 2019 grace period). Their spouses are also ineligible for HSA contributions during this period if the spouses’ medical expenses can be reimbursed from the health FSA. And because qualified beneficiaries who are receiving COBRA coverage under the health FSA on the last day of the plan year are also entitled to the grace period, they too are ineligible for HSA contributions during the grace period. However, grace period coverage is disregarded if the health FSA has a $0 balance at plan-year-end.
The problem is alleviated by the “full-contribution” rule for HSAs, which allows an individual who is HSA-eligible on December 1st to make a full year’s worth of HSA contributions if certain additional requirements are met. Therefore, being ineligible for three months due to a health FSA grace period affects the timing of HSA contributions but will not necessarily prevent an individ-ual from making the full HSA contribution. Your company could also avoid these HSA eligibility issues by amending its cafeteria plan to convert the general-purpose health FSA to one of the following HSA-compatible arrangements for their entire grace period:
a limited-purpose health FSA (i.e., a health FSA that reimburses only dental, vision, or preventive care expenses);
a post-deductible health FSA (i.e., a health FSA that reimburses medical expenses only if incurred after the minimum annual HDHP deductible has been satisfied); or
a combination limited-purpose/post-deductible health FSA.
The amendment must apply on a mandatory basis to all health FSA participants who are entitled to the grace period; thus, participants may not choose between general-purpose and HSA-compatible health FSAs for the grace period.
Note that an alternative would be to offer health FSA carryovers. (For information about carryovers, including their impact on HSA eligibility, see our Checkpoint article.) Note also that employee communications will be needed to explain how the grace period works, including its impact on HSA eligibility. Even if your company does not sponsor an HDHP or offer HSAs, some employees (or their spouses) may already have or may be considering HSAs and will need to understand how the grace period will affect eligibility for HSA contributions.
For more information, see EBIA’s Cafeteria Plans manual at Sections XVI.B.2.b (“The Grace Period Must Apply to All Participants”), XVI.B.3.a (“How Does a Health FSA Grace Period Affect HSA Eligibility?”), and XXI.H (“Carryovers and the Use-or-Lose Rule”). See also EBIA’s Consumer-Driven Health Care manual at Section XVIII.B.6 (“How Does a Health FSA Grace Period or Carryover Affect HSA Eligibility?”).
Contributing Editors: EBIA Staff.