Coming out of an FSA Grace Period? Time to Set Your HSA Contribution Activity in Motion!

Your Health FSA grace period prevented you from opening and funding a Health Savings Account when your HSA-qualified coverage became effective Jan. 1. It's time to set the Health Savings Account wheels in motion.

General Health FSA enrollees whose plan years ended Dec. 31 but who carried a balance into a grace period have not been eligible to open a Health Savings Account or make or receive contributions yet in 2025. With the end of the grace period in sight, now is the time to make sure you don't miss any the opportunity to utilize your new account as soon as the law says that you can.

Let's examine this issue.

FSA Grace Period

Many employers add a grace period to their Health FSA (and Dependent Care FSA) plan. Designed to reduce employees' forfeiting unused balances, the grace period is an additional two months and 15 days that participants can continue to spend that year's elections on qualified expenses. In effect, employees have overlapping 14.5-month plan years, that is, 14.5 months to spend each 12 months' election.

The grace period offers more than just an opportunity to minimize forfeiting balances (though that is the primary reason that a company chooses this option). It can also help employees double their spending power.

Example: Your child (or you) needs orthodontia. The doctor offers a 10% prompt-pay discount if you pay the $7,000 bill up front, rather than in monthly installments. You scheduled treatment to start between Jan. 1 and March 15, 2025. You can apply your unspent 2024 election ($3,200) and your full 2025 election ($3,300) to pay the orthodontist $6,300 (the $7,000 price less the 10% - or $700 - discount). Not only do you save $700 off the top, but you reduce your taxable income by $6,500, saving about $2,250 in taxes. You purchase a $7,000 service for a net reduction in spending power of about $4,050 (or a 42% discount). Pretty impressive.

By giving participants more time to spend their balances, grace periods reduce forfeitures, thereby encouraging more employees to participate and for those who do enroll to increase their elections. Grace periods, like their counterparts, carryovers (a separate either-or employer option that allows participants to carry over a limited amount of unspent balances to spend at any time during the following plan year), are good news for employees who remain committed to a Health FSA. They are, however, problematic for employees who want to transition from a Health FSA to a Health Savings Account.

The Dangerous Intersection of a Grace Period and Health Savings Accounts

Although the grace period offers these important benefits, it can harm employees who want to enroll on an HSA-qualified plan for the first time and open a Health Savings Account. By extending the time that you have to spend your general Health FSA election, the grace period continues to disqualify you from funding your Health Savings Account.

If you spend your full 2024 election and submitted receipts to zero out your account by Dec. 31, the grace period didn't apply to you. You were HSA-eligible Jan. 1. You are on your way to building medical equity.

If your 2024 general Health FSA had a positive balance, however small, you are not eligible to open and fund a Health Savings Account before the end of the grace period (March 15). And because eligibility is determined as of the first day of the month, you can't open, establish, or make or receive contributions to your Health Savings Account before April 1. No foolin'.

April 1 is fast approaching, however, so now's the time to focus not on the possible lost opportunity, but rather what you must do during the next week or two to hit the ground running when you are eligible to open your Health Savings Account.

What Do You Need to Do Now?

So, what do you need to do now that the grace period is almost over?

1. Remind your employer that you'll be HSA-eligible April 1 (assuming you meet all other eligibility requirements). Your employer should know this, but don't leave it to chance.
2. Confirm your company's employer-contribution policy. Employers have wide latitude in how they design their contributions. If yours deposits funds quarterly, monthly, or per pay period, you'll begin to pick up contributions at the beginning of the second quarter. If the company makes an annual lump-sum or semiannual contribution, ask whether you're entitled to the full contribution, a prorated amount, or none of the contribution. Each of these approaches is permitted. You need to understand, if you haven't explored this topic already, how much money you will receive when you open your Health Savings Account and the amount and timing of your remaining employer contributions.
3. Contact your Health Savings Account administrator to activate (or sign up for) your account. It won't become active until April 1, but prepare now. You want to make sure that your account will be open to receive funds on April 1. Ask your administrator what else you need to do (like establishing a beneficiary who receives your balances if you die, or opting for electronic delivery of monthly statements and annual tax forms to avoid charges for paper copies).
4. Ask your administrator about the rules governing the establishment of your Health Savings Account. This date is important because you can't reimburse tax-free any expenses with dates of service prior to the date of establishment. The date is set by state law. It's usually the day that the first deposit is processed, but it may be earlier, depending on the state whose laws govern your Health Savings Account. If your account isn't established until the first deposit, ask how you can deposit a token amount April 1. If you wait until your first semi-monthly payroll deposit that isn't processed until, say, April 16, you may lose the opportunity to reimburse a large early-April expense.
5. Sign up for pre-tax payroll deductions. Usually, you sign up through your company or its payroll processor, but sometimes the Health Savings Account administrator processes your requests. You want to start funding your account as soon as you can.

Take these steps now. Don't procrastinate until we know which schools will be in the March Madness Final Four (March 30). You need time. Time to understand what you must do. Time to act. Time to confirm your actions.

The Bottom Line

Perhaps in the future the transition from a general Health FSA to a Health Savings Account won't be as problematic. That will be great for our children and grandchildren. Be sure that you live in current times, understand today's rules, and take the appropriate action to become HSA-eligible as soon as you can under current law.

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HSA Monday Mythbuster is published every other week, alternating with HSA Question of the Week on Mondays. The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.