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Acing The Transition From A Health FSA To An HSA
For people with Health FSAs, HSAs are an attractive option because the funds belong to them, not their employers, and are portable during job changes and retirement. In addition, HSA funds have no use-it-or-lose-it limits and can be invested for long-term growth.
However, moving from a Health FSA to an HSA isn’t always straightforward; if you don’t know the rules, you could end up losing your HSA eligibility. Here are a few FAQs to help you wrap up your Health FSA cleanly and easily transition to an HSA:
If I have a Health FSA, am I HSA-eligible?
No, you aren’t. If you’ve opted in to your employer’s Health FSA plan, you are not eligible to contribute to an HSA, even if you meet all other HSA eligibility requirements. The IRS views general Health FSAs as disqualifying medical coverage and doesn’t allow them to be combined with HSAs.
Am I HSA-eligible if I’m not covered by an FSA, but my spouse is?
No, you are not. Your spouse’s Health FSA coverage disqualifies you from contributing to an HSA, even though you yourself don’t have a Health FSA.
If I spend all of my Health FSA balance before my plan year ends, am I HSA-eligible?
No, you are not. Even if you have a zero balance on your Health FSA, you are not HSA-eligible until your plan year ends.
If I’m in the middle of my Health FSA plan year and am otherwise HSA-eligible, can I opt out of my Health FSA plan mid-year and start making HSA contributions?
No, you cannot. Once you’ve opted in to your Health FSA coverage, you can only change your enrollment status after a qualifying event, such as marriage or divorce. You are not allowed to opt out of your Health FSA coverage before your plan year ends just because you’d rather have an HSA.
If I become otherwise HSA-eligible during my Health FSA plan year, what are my options?
Remember, part of being HSA-eligible is being enrolled in an HSA-qualified health plan. If your health insurance open enrollment falls on a different date than your Health FSA plan year anniversary, you can enroll in the HSA-qualified plan before your FSA plan year ends. You can pay for your medical expenses with your Health FSA funds, but you can’t make HSA contributions until your FSA plan year ends. Also, you cannot change your Health FSA elections during health insurance open enrollment if you opt into a HSA-qualified health plan and expect to face higher pre-deductible medical costs.
In addition, you can also delay enrollment in the HSA-qualified plan for a year, not renew your Health FSA, and enroll in the HSA-qualified plan the following year. In this case, however, you’ll face a period where you won’t have tax-free FSA or HSA funds to pay for your healthcare expenses.
If my Health FSA has a grace period, what does that mean for my HSA eligibility?
Some Health FSAs have a period of time after the plan year ends where accountholders with remaining funds are allowed to spend those funds. This period is typically 2.5 months and is known as a grace period. If your Health FSA has a grace period and you want to make HSA contributions after your FSA plan year ends, you must make sure to spend every penny of your Health FSA funds before your grace period starts.
If you carry even one penny of FSA balance into the grace period, you will not be HSA-eligible until the grace period ends. It doesn’t matter if you spend the remaining funds before the grace period is up; you’ll still have to wait until the grace period is over to make HSA contributions. And since HSA eligibility is determined at the start of each month, if your grace period ends mid-month, you won’t be HSA-eligible until the beginning of the following month.
If my Health FSA has a rollover option, what does that mean for my HSA eligibility?
Many Health FSAs are structured so any unused funds are lost at the end of the plan year, but some are set up to allow rollovers of up to $500. Rolled-over funds are moved to the following plan year and can be kept indefinitely until your FSA is closed.
If your Health FSA has a rollover option and you’d like to make HSA contributions, you can either spend down your funds by the end of your plan year, decline participation in the rollover option, or have your employer move any unused funds into a Limited-Purpose Health FSA (more on that in the next question). If you enter the rollover period with a balance and haven’t declined participation, you won’t be HSA-eligible until the rollover period ends (usually the end of the next plan year). In addition, you aren’t allowed to roll your Health FSA funds into an HSA.
Are there any types of FSAs I can have and still keep HSA eligibility?
Yes, you can still be HSA-eligible if you have any of the below three FSAs:
• Limited-Purpose Health FSA, which only covers dental and vision costs (you must actually have a Limited-Purpose Health FSA; you can’t just only use general Health FSA funds on dental and vision costs)
• Post-Deductible Health FSA, which only reimburses medical expenses after you reach your deductible
• Dependent Care FSA, which covers costs for watching dependents while you and your spouse work or go to school
If you’d like to learn more about how HSAs stack up against FSAs, we’ve created a handy, thorough comparison. Get the comparison here.
Or, if you’re HSA-eligible and ready to start making contributions, you can open a HealthSavings HSA today.
How Your Embedded Deductible Can Ruin Your HSA Eligibility
High deductible health plan (HDHP) coverage for families can have either aggregate or embedded deductibles (see below). If your plan has an embedded deductible and you’d like to make HSA contributions (or if you have an existing HSA you’d like to keep contributing to), you need to know how high your embedded deductible is. If it’s too low, it can disqualify you from contributing to an HSA.
An aggregate deductible is when each family member in your plan is covered under the same deductible. For instance, if your aggregate deductible is $5,000, your insurance company will not pay anything until the deductible is reached, no matter which family member incurs the cost.
So if you incurred a $3,000 medical expense and your spouse incurred a $1,500 medical expenses, you would have to pay all $4,500. You would only have $500 more to pay until your insurance kicked in, though.
An embedded deductible is when your deductible has a lower limit embedded for each individual. For instance, if your total annual deductible is $5,000 and your embedded deductible is $2,500, an individual only has to pay $2,500 of medical expenses before your plan’s after-deductible benefits begin.
Using the example above, having an embedded deductible would mean that after you paid $2,500 of medical expenses, your insurance would help with the other $500. However, another individual covered by your family plan would have to incur $2,500 of medical costs before your plan’s after-deductible benefits would kick in.
To be HSA-qualified, the embedded deductible for family HDHP coverage must be higher than the current minimum annual deductible set by the IRS.
For 2020, the minimum annual deductible for family HDHP coverage is $2,800. The embedded deductible coverage shown in the example above does not meet the IRS’ minimum annual deductible, so it does not qualify as HSA-eligible coverage.
If you’re considering family HDHP coverage that has an embedded deductible, make sure to check whether the embedded deductible is higher than the IRS’ current minimum annual deductible. If it’s not, you won’t be able to contribute to an HSA under that coverage.
Making Sense of the HSA Testing Period
The testing period is a 13-month period where you must keep HSA eligibility or face a tax penalty. It comes into play in these three scenarios:
1. When you use the last-month rule to make a full year’s contribution even though you opened your HSA mid-year
2. When you transfer your IRA or Roth IRA to your HSA
3. When you transfer your FSA or HRA to your HSA
• For the first scenario, the testing period is the 13-month period starting on Dec. 1 of the year the HSA was opened and ending on Dec. 31 of the next year.
• For the second and third scenarios, the testing period is the 13-month period starting on the first day of the month when the transfer happened and ending on the last day of the following 12th month (if you made a transfer in June, the testing period would be until the end of the following June).
• For the first scenario, if you lose HSA-eligibility during the testing period, you’ll have to include the portion of your contribution that was only possible through the last-month rule as taxable income (see an example here).
• For the second and third scenarios, you have to include the transfer amount as taxable income. In each case, you have to pay an additional 10% penalty on either ineligible funds.
Unlike a normal excess contribution, you do not have to remove the contributions from your accounts or pay the 6% excise tax on the funds.
The testing period rules don’t apply if you lose HSA eligibility due to death or disability.