How to Prevent Employees from Forfeiting FSA Money Without Losing HSA Eligibility
February 28, 2021
The Internal Revenue Service recently issued guidance for participants of health care flexible spending arrangements (“health FSAs”) concerning new relief added by the Consolidated Appropriations Act of 2021 (CAA). As a result of COVID-19, participating employees are more likely to have unused health FSA amounts at the end of 2020 and 2021. Fortunately, the CAA permits programs to be amended retroactively so long as they are amended by the last day of the first plan year beginning after the end of the plan year in which the amendment is effective. Importantly, the IRS guidance confirms several ways that the relief could be offered by employers without negatively impacting an employee’s HSA eligibility.
The CAA provides a number of options from which employers may choose for their health FSA plans, including the ability for an employer to offer an unlimited carryover of health FSA funds for both the 2020 and 2021 plan years or an extended grace period of up to 12 months for either or both years. While this relief may sound like good news for health FSA plan participants, many employers also offer HSA-qualified health insurance plans with HSAs, and a health FSA with a grace period or a carryover generally disqualifies the individual from HSA participation in the following year. Employers generally have three options as they search for ways to encourage participation in their HSA-qualified health plans without disqualifying employees’ HSA eligibility.
Option 1. Employers can amend their health FSA program to allow any amount leftover at the end of the plan year to automatically roll over into a limited-purpose FSA for the following year for any employee that enrolled in the employer’s HSA-qualified health plan for that following year. Employers could also amend their program to allow each employee to elect to participate in an HSA-compatible health FSA or a general purpose health FSA during the grace period or rollover period. Employers that already offer an HSA-compatible health FSA may find this option to be the easiest to implement. Those that don’t may find this to be too confusing as well as administratively challenging.
Option 2. Employers can amend their health FSA program that permits funds remaining at the end of the plan year to automatically rollover to the following plan year so that each employee has the option to opt out of the rollover. The new IRS guidance permits employees to opt out of the automatic rollover for 2021. While this may be administratively burdensome for employers, it provides another option for any employer that wants to provide relief.
Option 3. Employers and amend their health FSA program to add a grace period or rollover feature but limit the period to less than 12 months. Although employees would not eligible to make HSA contributions for the months that the grace or rollover was available, the employee could make HSA contributions for the months of the year after the grace period or rollover period ends. In addition, employees that are HSA-eligible on December 1 of 2021 could take advantage of the “last month rule” and make a full-year contribution for 2021. However, employers should remind these employees of the “testing period” that follows, requiring these employees to maintain their HSA eligibility for the entire 2022 calendar year to avoid paying income tax and a 10 percent penalty on their additional contributions.
Final thoughts. Employers should check with their health FSA program vendor to ensure that they can accommodate any options that may be desirable. Employers should also consider whether they may want to amend their program to allow participants to make a mid-year change to their 2021 to help employees avoid forfeiting large unused balances at the end of 2021. Adding or changing a grace period or rollover will require a plan amendment to be made by December 31, 2021 for any changes to the grace period or rollover for 2020. All that remains is explaining these changes to employees so they understand how they are being “helped.”
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