Looking to Tap Your HSA Election to Pay a Bill Now? Wrong Account!

You may have enrolled in a Health FSA in the past and enjoyed the feature that allows you to spend your full election early in the plan year. You probably don't have that option with your Health Savings Account.

One of the great features of a Health FSA is that you can spend your entire annual election on the first day of the plan year. Participants who understand this benefit can schedule a dental implant or pick up a new pair of bifocals early in the plan year and pay not only with pre-tax funds, but also spend money that they haven't yet saved or had deducted from their paychecks.

Health Savings Accounts don't include this feature. Is that a shortcoming, or do Health Savings Accounts offer benefits that offset this Health FSA advantage?

Uniform Coverage

Health FSA plans are required to offer uniform coverage. Under this provision of the federal tax code, participants have immediate access to their full annual election. They can spend their election amount early in the year for dental work, vision-correction surgery, new eyeglasses, or a medical treatment. They then repay the funds through level payroll deductions during the plan year.

This feature provides peace of mind. Participants don't have to worry about how they'll finance an expense that they incur early in the year, or weigh the risk to their health if they delay a treatment until they've accumulated a sufficient balance. Instead, they draw on their binding election and, in effect, receive an interest-free loan that they repay in regular installments.

Because Health FSA participants make an annual binding election that they can't change except for certain qualifying life events (like birth, adoption, divorce, marriage, and death), employers face minimal risk of an employee's failure to pay. After all, they control the payroll system, so they deduct the amount owed before employees can access those funds.

If a participant loses eligibility to continue participation in the Health FSA (usually due to leaving employment, but sometimes due to a reduction in hours that results in a loss of eligibility for employer-sponsored benefits), the company must cover the balance. That's a risk that employers assume when they sponsor a Health FSA.

The Flexibility of Health Savings Accounts

Health Saving Accounts don't offer this feature. Why? Because account owners don't make a binding election or promise to fund the account at a certain level during the plan year. In fact, the Health Savings Account isn't an employer-sponsored plan and thus doesn't have a plan year.

Come again?

A Health Savings Account is a personal trust. It's not an employer-sponsored benefit like a medical or dental plan or an FSA. Health Savings Account owners can adjust their contributions prospectively (applying to future deposits only) at any time. These adjustments can be up or down. They can be pre-tax payroll deductions through an employer's Cafeteria Plan or tax-deductible contributions of personal funds.

This flexibility is generally an advantage over Health FSAs. Whereas Health FSA owners can't increase their election when they must undergo an expensive test or treatment or decrease their election when they determine that they need less money than they projected, Health Savings Account owners can adjust their election to meet their emerging needs.

Because Health Savings Accounts have no plan years, owners aren't required under federal tax law to make annual (nonbinding) elections (though some employers require an annual nonbinding payroll-deduction commitment during open enrollment).

This flexibility comes with a small cost: Because owners don't make a binding election against which they can borrow, as Health FSA owners can under the uniform-coverage provision, they generally can't spend more than they've accumulated in their account.

Alternatives for Health Savings Account Owners

So, how do Health Savings Account owners pay for an unexpected qualified expense if their current balance is insufficient? Here are several approaches:

Accumulated balances. Because Health Savings Account don't have a use-it-or-lose-it feature, owners can accumulate balances over time by contributing more than they withdraw (or a combination of contributions and investment returns that are greater than distributions). Across all Health Savings Account owners, balances increase annually as contributions exceed distributions. That's not true for every account owner, but that's the industry trend. Those accumulated balances are in effect an emergency medical fund that can reimburse today's or tomorrow's qualified expenses tax-free.

Payment plan. Some owners work out repayment plans with their medical providers (as I have on several occasions). Most physicians, hospitals, and imaging centers (but not pharmacies) will negotiate repayment schedules to accept full payment over time rather than turning the patient's account to a collection agency and perhaps receiving pennies on the dollar.

These payment plans can stretch over several years. That's because Health Savings Account owner, unlike Health FSA participants, aren't limited to paying a qualified expense with that year's deposits. That's because there is no time limit on tax-free distributions for qualified expenses through a Health Savings Account, unlike a Health FSA. A Health Savings Account owner with a $150 monthly payment to a provider can fund that obligation with a contribution that she quickly withdraws to pay the physician or facility.

Advance payments. Some Health Savings Account providers offer a program that permits employers to offer cash advances against future contributions. These programs mimic a cash advance or overdraft protection on a personal checking account. They're structured differently, though, because Health Savings Accounts can't be pledged as collateral for a loan (including overdraft protection).

Not all account providers offer this option. And many employers are reluctant to extend it to employees because the company is responsible for repaying the debt to the account provider if the employee fails to fulfill her repayment responsibility.

Payroll loan. One of my first Health Savings Account employer clients made a deal with employees. The family deductible was $3,000. The company would contribute $1,000 annually. Each employee who committed to payroll deductions of at least $2,000 (thereby covering the deductible) would be eligible for a payroll loan if his qualified expenses exceeded his account balance. The company would extend the loan and collect repayments in equal installments during the balance of the calendar year.

The Role of a Limited-Purpose Health FSA

If a Health Savings Account owner knows that she will incur a large dental or vision expense (perhaps restorative dental work or vision-correction surgery - members of my family have done both in recent years) early in her first year of account ownership and her employer offers a Limited-Purpose Health FSA (many don't), she can leverage this opportunity.

The Limited-Purpose Health FSA limits reimbursement to dental and vision expenses and has the uniform-coverage feature of a general Health FSA. It's a use-it-or-lose-it account, so an employee shouldn't make a binding election unless she's sure she'll undergo the treatment. If she's not sure or the service will be scheduled much later in the year, she may be better off foregoing the Limited-Purpose Health FSA and adding to her Health Savings Account contributions. After all, she never loses funds that she deposits into her Health Savings Account, and she has more of an opportunity to accumulate enough money the later in the year she incurs the expense.

The Bottom Line

At first glance, the absence of uniform coverage may seem like a disadvantage for Health Savings Accounts relative to Health FSAs. But remember that uniform coverage is possible when an employee makes a binding commitment that can't be adjusted based on the need for more or less money in the account that year. That binding election often leaves participants with too much money (forfeiting balances to the company) or too little money (lose tax benefits) during the plan year.

The longer an owner actively funds a Health Savings Account, and the more she understands how to leverage the flexibility of these accounts to meet her financial needs, the better her financial position when she faces current or future medical bills.