QUESTION: Our company currently offers a low-deductible major medical plan. We are thinking of adding a high-deductible health plan (HDHP) as another option, so that employees who choose the HDHP can establish and contribute to HSAs (if they otherwise meet the HSA eligibility requirements). But we are concerned about employees who establish HSAs and later become ineligible, for example, by enrolling in our low-deductible plan during a future open enrollment. Will these employees still be able to receive distributions from their HSAs?
ANSWER: Yes. Although employees who switch from your high-deductible plan to a low-deductible plan will no longer be eligible to contribute to their HSAs on a tax-favored basis (or have others contribute on their behalf), they will still be able to receive distributions from their HSAs.
As background, only HSA-eligible individuals may contribute to HSAs or have their employers, family members, or other individuals contribute to their HSAs on their behalf. Generally, individuals are eligible for HSA contributions if they have qualifying HDHP coverage (i.e., coverage that provides significant health benefits and meets statutory requirements for annual deductibles and out-of-pocket expenses), have no impermissible non-HDHP coverage, are not entitled to Medicare, and cannot be claimed as another person’s tax dependent.
While employees must be HSA-eligible individuals to make HSA contributions (or have contributions made by others on their behalf), they do not have to be HSA-eligible individuals to receive HSA distributions. Thus, employees who switch from an HDHP to a low-deductible health plan can still receive HSA distributions. If distributions are used to pay or reimburse Code § 213(d) medical expenses, they will be tax-free. However, distributions for nonmedical expenses will be included in the employees’ gross income and will generally be subject to an additional 20% excise tax. The excise tax does not apply to nonmedical distributions made after the employee reaches age 65, dies, or becomes disabled.
For more information, see EBIA’s Consumer-Driven Health Care manual at Sections IX.F (“Treatment of HSA After Eligibility Ends”), XV.D (“Timing Issues for Tax-Free HSA Distributions”), and XV.E (“HSA Distributions for Nonmedical Expenses”).
Contributing Editors: EBIA Staff.