FSA Election Changes and High Deductible Health Plan Enrollment

By: HUB’s EB Compliance Team

Most often, employees associate High Deductible Health Plans (“HDHPs”) with Health Savings Accounts (“HSAs”). However, individuals who have a Flexible Spending Account (“FSA”) (or are covered by one) when they enroll in an HDHP may be surprised to learn they have limited options for changing their FSA elections. For purposes of this article, “FSA” refers to a general purpose health FSA that reimburses for most or all medical expenses rather than a limited purpose FSA which is designed to be HSA-compatible.

HSA Background

HSAs are tax-favored, IRA-type accounts that can be contributed to by, or on behalf of, individuals who are covered by HDHPs. Employees can accumulate dollars in the account and carry them over year after year. HSA funds may be used to pay for certain qualified medical expenses on a tax-free basis. However, to establish or contribute to an HSA, the individual cannot be covered under any other health plan that is not an HDHP, which includes an FSA.

FSA Background

Elections to contribute to FSAs are governed by the cafeteria plan rules in Section 125 of the tax code. A hallmark of cafeteria plans is that plan elections generally must be irrevocable for the period of coverage, which is typically the plan year. Outside of limited exceptions described below, once a participant makes an election for the plan year, it cannot be changed.

The exception to this rule is when a participant experiences a qualifying event as defined by the cafeteria plan rules. Examples of qualifying events include loss of eligibility for other group coverage, marriage, changes in the number of dependents, and changes in Medicaid eligibility. Notably, merely experiencing a qualifying event does not necessarily allow all plan elections to be changed. Certain qualifying events may only allow a specific change to be made, such as dropping coverage for a dependent who ages off the plan.

FSA Election Changes

Many qualifying events allow changes to plan elections, but do not allow changes to FSA elections, or only allow FSA elections to be increased. This is by design to protect employers from losses due to the uniform contribution rule, which requires the entire elected amount to be available as of the beginning of the plan year.

If FSA election changes were easily allowed, participants could overspend their accounts, only to reduce elections upon experiencing a qualifying event. This would leave employers on the hook for these overspent amounts.

An example of a qualifying event that does not allow changes to FSA elections is a termination of a spouse’s employment. For example, Ethan and Harper are married and each covered under their respective employer health plans. Harper has also elected to make FSA contributions under her employer plan. If Ethan terminates from his employer, Harper experiences a qualifying event, which allows her to add Ethan to her health plan coverage. However, Harper cannot use this qualifying event to stop her FSA contributions.

A Common Scenario

Assume Portia works for ABC Corp, which sponsors a calendar year FSA and a health plan with a plan year that runs from on June 1 to May 31. For the 2023 calendar year, Portia elects FSA contributions while she is enrolled in the PPO health plan. At open enrollment for the health plan in 2023, Portia decides to enroll in the HDHP starting June 1 rather than the PPO. She believes this will allow her to stop her FSA contributions to make has contributions. Unfortunately, she is incorrect.

Although HDHP enrollment is required to make HSA contributions, HDHP enrollment does not mean FSA eligibility is lost. Additionally, while her health plan election has changed, she has not experienced a qualifying event that would allow her to change her FSA election. Portia is now enrolled in the HDHP but stuck with her previous FSA election until open enrollment for the FSA, unless she experiences a qualifying event that would allow her FSA election to be changed.

To further complicate matters, Portia may not be able to make HSA contributions once her current FSA plan year ends. As we discussed here, whether the FSA includes a grace period or carryover, and whether Portia has any funds available as of the last day of the plan year, will impact the timing of when Portia would be eligible to make HSA contributions.

Conclusion

Employers with FSAs and health plans that operate on different plan years may wish to consider educating employees on these rules. Such education may help avoid employees being unhappy with their elections and unable to change them after the fact. Employees would still require foresight to know they were going to move to the HDHP to take advantage of the education.

In addition, when an employee has a qualifying event, employers should consider carefully whether that event allows the employee to reduce or eliminate FSA contributions.

As a potential workaround, employers can offer a limited purpose FSA option to their employees. Employees moving to an HDHP may then be able to convert their general or health FSA to an HSA compatible limited purpose FSA (other than during the grace period, which the IRS does not allow). Although conversion would allow the participant to make HSA contributions, they would be limited to using the FSA funds on dental and vision expenses. Employers who offer a limited purpose FSA will want to understand whether the FSA vendor allows for mid-year conversion before communicating this to employees and consult with experienced employee benefits counsel.

If you have any questions, please contact your HUB Advisor. View more compliance articles in our Compliance Directory.

NOTICE OF DISCLAIMER

Neither Hub International Limited nor any of its affiliated companies is a law or accounting firm, and therefore they cannot provide legal or tax advice. The information herein is provided for general information only and is not intended to constitute legal or tax advice as to an organization’s or individual's specific circumstances. It is based on Hub International's understanding of the law as it exists on the date of this publication. Subsequent developments may result in this information becoming outdated or incorrect and Hub International does not have an obligation to update this information. You should consult an attorney, accountant, or other legal or tax professional regarding the application of the general information provided here to your organization’s specific situation in light of your or your organization’s particular needs.