How to Provide Relief to Your FSA Participants Without Impacting Their HSA Eligibility
Last month, we wrote a post on the relief items for FSA participants added by the Consolidated Appropriations Act of 2021 (“CAA”). The CAA provides a number of relief items for plan participants that employers may choose to implement for their health FSA and dependent care FSA plans. This relief includes the ability for an employer to offer an unlimited carryover of health FSA funds for both the 2020 and 2021 plan years or an extended grace period of up to 12 months for both years.
While this relief may seem great for plan participants (and burdensome for employers), many employers offer high-deductible health plans (HDHPs) with HSAs in addition to sponsoring a health FSA. As a reminder, an individual is not eligible to contribute to an HSA if they have other disqualifying coverage and a health FSA is disqualifying coverage, unless it is a limited purpose FSA (e.g., only covers dental and vision expenses) or post-deductible FSA, collectively referred to as HSA-compatible FSA. A health FSA with a grace period or a carryover generally disqualifies the individual from HSA participation in the following year as well. Many employers are still trying to find ways to encourage participation in their HDHPs and disqualifying an individual from being HSA eligible is discouraging the switch opposed to encouraging it.
Last week, the IRS issued additional guidance on the FSA relief provided for in the CAA and this guidance offers and confirms several ways that the relief could be implemented by a plan without negatively impacting an employee’s HSA eligibility. The guidance addresses other items as well, but this post is sticking to the options an employer has if it wishes to amend its health FSA plan to offer a grace period or carryover yet not impact an employee’s HSA eligibility.
The first option is that an employer could amend its plan to provide that any amount leftover at the end of the plan year would automatically switch into a limited purpose FSA for the following year for any plan participant who enrolled in the HDHP in the latter year. Employers can also amend their plans to provide employees a choice between an HSA-compatible FSA or general purpose FSA during the period to which the carryover or grace period applies on an employee-by-employee basis. If you don’t currently offer an HSA-compatible FSA option, this may be too administratively burdensome and confusing to offer an HSA-compatible FSA option for the first time now. If you already offer an HSA-compatible HSA, this option may be the easiest to implement.
The next option that employers have is to amend their plan for a carryover in the plan, but allow employees the option to opt out of the carryover on an employee-by-employee basis. This is also not a new option; however, prior guidance permitting this opt-out provided that the election had to be made prior to the start of the year (i.e., before the carryover actually carried over). The IRS guidance does not state the opt out has to occur prior to the beginning of the year, which would not be practical for a 2020 carryover given this guidance came out after the start of the year and the CAA wasn’t even signed into law until December 27th. While an employee-by-employee opt-out may be more burden than an employer wishes to deal with, it does still provide an option for an employer that really wants to provide relief.
The third option is for an employer to put in a grace period or carryover but limit the period to less than 12 months. While an employee would not be HSA eligible in the months that the grace or carryover was available, the employee could contribute in the remaining months of the year and may still be able to contribute the full amount to the HSA as long as they have no disqualifying coverage and are eligible to make HSA contributions on December 1st of that year and remain HSA eligible the entire following year.
All of these options add administrative burden to employers. So if you are considering adding or expanding a carryover or grace period provision, we recommend first reviewing your 2020 health FSA balances to determine if there are that many participants that will even benefit from the relief. If implementing the relief makes sense, check with your FSA vendor to ensure that they can accommodate the option that you wish to implement. Consider whether you should also amend the plan to allow participants to make a mid-year change to their 2021 elections or participants who assumed their unused 2020 balances would be forfeited may find themselves in the same boat at the end of 2021 with high unused balances. Next, communicate any changes to your participants as soon as decisions are made. Finally, don’t forget that adding or changing a grace period or carryover will require a plan amendment and this IRS guidance accelerates the amendment deadline to December 31, 2021 for any 2020 grace or carryover change.