Can't Get out of Health FSA to Open an HSA? Usually True, But . . .

Health Savings Account experts have preached for years that Health FSA participants can't disenroll from that program mid-year. But for a limited time, they now can.

It's a dilemma with no usual solution. A company runs its medical plan and Health FSA on different plan years. I see it frequently with municipalities, who are locked into a July 1 medical anniversary date and begin their Health FSA plan year either Jan. 1 or Sept. 1.

Why Jan 1? It's the tax year. Many companies use this logic, even when their medical plans renew at other times.

Why Sept. 1? Teachers often represent a large portion of a municipal work force, and those who change employers do so most often during the summer. If the Health FSA plan year begins July 1, they can spend their entire election and leave employment after making only a handful of payroll deductions toward t heir election.

Misalignment

When the medical-plan and Health FSA effective dates aren't aligned, an employer has difficulty offering a Health Savings Account plan. This program is most attractive to employees who understand the financial benefits of a reimbursement program that's funded with tax-free payroll deductions and that allows tax-free withdrawals for eligible expenses. Those target employees usually are enrolled in a general Health FSA, which offers the same tax benefits as a Health Savings Account (though with different rules, levels of rigidity, and time frames).

But they're disqualified from opening or funding a Health Savings Account if they are (or their spouse is) enrolled in a general Health FSA. And they can't become HSA-eligible by disenrolling from a Health FSA mid-year without a qualifying event . . . or spending their balances quickly . . . or signing an affidavit promising not to seek reimbursement for medical, prescription-drug, or over-the-counter expenses. They're covered by the Health FSA for the entire 12-month plan year.

Less-Than-Desirable Options

In most circumstances, employees' options aren't very enticing.

• They can enroll in the HSA-qualified plan and not be eligible to open and fund a Health Savings Account until the end of their Health FSA plan year. They forfeit months of tax savings on personal contributions and often employer deposits as well. They can use their Health FSA balances to pay their qualified expenses, but they funded those accounts based on lower medical costs.
• They can delay enrollment in the Health Savings Account plan for a year, not re-enroll in the Health FSA, and then enroll in the new program the following year. They'll be eligible to open and fund a Health Savings Account immediately. But they'll have months preceding that coverage without access to any tax-free funds to reimburse qualified expenses.

Under either approach, they can't reimburse certain qualified expenses tax-free because of either timing or volume of such expenses.

A Window Opens a Little in 2020

Employees in this situation may have a window of opportunity in 2020. Take the case of a company that runs the Health FSA on the calendar year and introduces a Health Savings Account program effective July. 1, 2020. Ordinarily, employees who enroll in the new plan wouldn't be eligible to open or fund a Health Savings Account before Jan. 1, 2021.

But guidance issued last month by the Internal Revenue Service allows employers to offer employees a special mid-year enrollment period during which they can prospectively enroll in, disenroll from, or change their election to their Health FSA (as well as employer-sponsored medical coverage). If an employee elects to disenroll from the period as of the first day of the following month, he's no longer disqualified from opening and funding a Health Savings Account.

Employer's don't have to offer the special mid-year open enrollment. And employee changes apply to the future, not the past. Even with these restrictions, this new guidance can be useful to employees in certain situation, including:

Example 1: Nicole is enrolled in a calendar-year Health FSA. She wants to enroll in her employer's new Health Savings Account program on the July 1 anniversary date, but she knows that she won't be able to open or fund an account until Jan. 1, 2021. If her employer allows her to make mid-year changes to her Health FSA, she can disenroll effective July 1 and enroll in the HSA-qualified plan as of that date. She can open and fund her account immediately.

Example 2: Tiffany is enrolled in a calendar-year Health FSA. Her employer introduced a Health Savings Account program effective April 1. She really wanted to join, but decided to defer a year and accept a three-month gap (Jan. 1 through March 31, 2021) when she wouldn't be able to reimburse qualified expenses tax-free from a Health FSA (expired) or Health Savings Account (not yet funded). If her employer allows a mid-year open-enrollment period for all elections in June, she can disenroll from the Health FSA and enroll in the HSA-qualified medical plan effective July 1. She can open and fund her Health Savings Account as of July 1.

Example 3: Kevin's enrolled in a Health FSA that runs from Sept. 1, 2019, through Aug. 31, 2020 and elected $750. He enrolled in his employer's HSA-qualified plan with a $2,000 deductible June 1, even though he knew he wouldn't be eligible to open or fund the account before Sept. 1. He's undergoing day surgery in mid-July. He can follow Nicole's example above. Or he can use his employer's mid-year open enrollment to increase his Health FSA election by $2,000 to cover his deductible expenses for the surgery. His payroll deduction will increase from $26.92 to $526.92 for the remaining four pay periods. But he values having the funds available to pay his expense on the day of the surgery, and under federal tax law he can spend up to his entire Health FSA election before his payroll deductions catch up with his spending. And effective Sept. 1, he can fully fund his Health Savings Account up to the limit of $3,550 (self-only coverage, under age 55), thus reducing his taxable income for the year by $6,050 ($500 of his $750 original Health FSA election, $2,000 of his new election, and $3,550 Health Savings Account contribution), rather than $4,050 ($500 remaining on his Health FSA election, plus a $3,550 Health Savings Account contribution).

This window won't be open for long. It' won't be open to every employee. And in some cases - Health FSA changes apply to future activity only, and the plan may be near the end of its year - it may have little effect on employees' participation in these programs.

But employers and employees have an unusual opportunity to act to minimize or eliminate the conflict between Health FSAs and Health Savings Account eligibility when the medical plan and reimbursement account plan years don't run concurrently. It's an idea worth exploring.

I'm director of strategy and compliance at Benefit Strategies, LLC, a provider of Health Savings Accounts and other tax-advantaged benefits. You can read my biweekly Health Savings Account GPS blog and subscribe by clicking here and my weekly HSA Wednesday Wisdom and occasional Healthcare Update column published on LinkedIn. I've also created your Health Savings Academy, an educational resource for financial and benefits professionals, as well as employers and account owners.My book, HSAs: The Tax-Perfect Retirement Account, is the definitive guide to navigating the intersection of Health Savings Accounts, Medicare, and retirement planning. It's available in book and e-book forms from Amazon.

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