Are HSA-Plan Enrollees Barred from General Health FSAs?

Federal tax law doesn't bar you from participating in a general Health FSA when you're enrolled in an HSA-qualified plan. But beware - it rarely makes sense to combine these two plans.

As is often the case, my friends in the benefits community ask a question that ends up as a Monday Mythbuster topic. I value these questions because they go beyond the theoretical and address questions with which benefits advisors, employers, and employees grapple.

Late last week, I was asked whether someone covered by an HSA-qualified plan could enroll in a general Health FSA, rather than open and fund a Health Savings Account.

Health FSA Eligibility Rules

Health FSAs follow a simple eligibility rule: If you're eligible for employee benefits, you can participate in your company's Health FSA plan. You can waive other coverage - medical, dental, vision, etc. - and make an election to a Health FSA. If you enroll in an employer-sponsored medical plan, there is no FSA-qualified design. You can elect a Health FSA whether your underlying medical coverage has no deductible (a rare design these days) or imposes a deductible up to the $9,100 federal limit (or $7,500 maximum for an HSA-qualified plan).

Your Health FSA election is then divided by the number of pay periods in the plan year and that amount deducted from each paycheck on a pre-tax basis. Those payroll deductions are, in effect, your premium for Health FSA coverage (a concept that will become clearer below).

Health Savings Account Eligibility Rules and General Health FSAs

To be eligible to open and fund a Health Savings Account, you must meet three eligibility requirements:

1. You must be enrolled in HSA-qualified coverage.
2. You can't be eligible for reimbursement under any form of disqualifying coverage.
3. You can't qualify as another person's tax dependent.

The first and third requirements are straightforward. The second is where people enrolled in an HSA-qualified plan have to be concerned.

Under federal tax law, a Health FSA is considered a medical plan. After all, you pay a premium (your annual election) and receive reimbursement for qualified expenses. A general Health FSA reimburses qualified medical, dental, vision, and over-the-counter expenses without applying a deductible. Because you receive first-dollar coverage for qualified medical care, you're disqualified from opening and funding a Health Savings Account. You can enroll in an HSA-qualified plan, but you can't enjoy the same tax benefits that your co-workers who are HSA-eligible experience.

But When You're Disqualified Anyway . . .

The fact that a Health FSA disqualifies you from opening and funding a Health Savings Account may not matter. Perhaps you're already disqualified. For example,

• you're a working senior who receives Social Security benefits and are automatically enrolled in Medicare Part A, which is disqualifying coverage.
• you're a working senior at a company with fewer than 20 employees, and your company's medical insurer requires you to enroll in Medicare Part A and Part B as a condition of remaining on the group plan. (Note: This mandatory Medicare enrollment isn't required by the federal government, but most insurers mandate enrollment for Medicare-eligible employees at small companies.)
• you're a veteran who has retained her TRICARE as a back-up medical plan.
• your spouse or your parent is enrolled in a general Health FSA. That plan automatically covers you, so you're not eligible to open and fund a Health Savings Account before the end of that plan year.

In each of these cases, you can't have a Health Savings Account, yet you may plan to incur qualified medical, dental, vision, and over-the-counter expenses. In that case, a general Health FSA will help you stretch your dollars by allowing you to pay those bills with pre-tax dollars.

Disqualifying Yourself with a General Health FSA

Are there any situations in which you don't have disqualifying coverage but choose to enroll in a general Health FSA to shut the door on your opening and funding a Health Savings Account?

Yes. Some reasons are better than others, however. Here are some examples:

1. You plan to enroll in Medicare early in the plan year. Why limit yourself to a couple of months of Health Savings Account contributions - particularly if you have self-only coverage and thus a lower annual funding limit - when you can elect up to $3,050 (or less, if your company's cap is lower) in a Health FSA? Choosing a Health FSA may make sense financially during the year that you enroll in Medicare. Andi it's your only health-account reimbursement option if you remain active at work and eligible for benefits.
2. You plan to leave the company early in the plan year. Health FSA plans must offer uniform coverage, which means that you can spend your full election at any time during the plan year. If you overspend your account (spend more than your employer has collected in payroll deductions), the company can't settle the difference in your final paycheck. This is a legal, though some will argue morally dubious, tactic.
3. You expect to incur a large expense early in the plan year. Health Savings Accounts don't offer uniform coverage because you don't make a binding election (you can change your contribution levels during the year) against which to withdraw funds. If you don't have a Health Savings Account already and expect a large expense early in the plan year, a Health FSA may ease your cash-flow fears. But a growing number of Health Savings Account administrators offer an option that allows you to take an advance against future contributions, so be sure to consider this option if you're otherwise HSA-eligible.
4. You expect to pay for an adult non-tax-dependent child's expenses. If you cover on your medical plan a child under age 26 who's no longer your tax dependent, you can reimburse his qualified expenses from a Health FSA (remember above - it's defined as a health plan, and under federal law a medical plan must cover a child to age 26). But you can't reimburse qualified expenses from a Health Savings Account for a child who is no longer your tax dependent (because a health Savings Account is a financial account, not a medical plan). There may be better options, though. Perhaps the child can participate in his company's Health FSA (which is open to all benefits-eligible workers, not just those enrolled on the company's medical plan). You can then give the child the equivalent of his election to make up for his lost net paycheck as you fund your Health Savings Account.

The Limited Health FSA Option

One way to possibly have the best of both worlds is to enroll in a Limited-Purpose Health FSA if your company offers this option. Because reimbursement is limited to qualified dental and vision expenses - coverage for these services isn't disqualifying - you can enroll in the HSA-qualified plan, open and fund a Health Savings Account if you're otherwise eligible, and make a Limited-Purpose Health FSA election as well.

But this option addresses the four scenarios immediately above only if the expenses that you want to reimburse are limited to medical and dental. If you plan to enroll in Medicare early in the year and want to continue to fund a Health Savings Account, your Health FSA will reimburse only dental and vision expenses through the end of the plan year. If you have a large expense early in the year and want access to your full election immediately, the service must be dental or vision. Ditto the reimbursement of a child's expense.

And note that you forfeit any remaining balances at the end of the plan year (though your employer may offer a grace period or limited carryover of unused funds to minimize this risk), just as you do with a general Health FSA. So, stacking a Health Savings Account and a Limited-Purpose Health FSA creates a potential risk (forfeiture of Health FSA balances) that you don't have with Health Savings Account balances.

The Bottom Line

Pairing an HSA-qualified plan with a general Health FSA should raise a red flag among benefits advisors, employers, and workers. There is a place for this combination, but in most cases it's restrictive, denying workers greater reductions in taxable income, balances to spend on qualified expenses in the future, and the flexibility to alter payroll deductions during the year to reflect changing needs.

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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.