Mid-Year Medical Plan and Calendar-Year FSA? The Options Aren't Ideal.

It pays to align medical-benefits renewal dates - medical plan and health FSA. Otherwise, employees may experience an uncomfortable transition.

This is the time of year that I field the most questions about general Health FSAs and medical plans whose plan years don't align. Unfortunately, this misalignment often creates problems - and always creates issues when the company is introducing or continuing a Health Savings Account program.

The Alignment Problem

Under the federal tax code, anyone who wants to open and fund a Health Savings Account must, among other requirements, not be covered by another medical plan that doesn't meet the definition of HSA-qualified coverage. A general Health FSA (one that reimburses qualified medical, dental, and vision services, as well as over-the-counter drugs, medicine, equipment, and supplies) doesn't meet that definition because it begins to reimburse medical and OTC expenses below a deductible of at least $1,400 for self-only or $2,800 for family coverage. Most Health FSAs provide first-dollar reimbursement for these services.

What complicates the situation is that a Health FSA reimburses not only an employee's qualified expenses, but also services incurred by the participant's spouse, tax dependents, and children to age 26. That's true even if those family members aren't covered on the participant's medical plan or don't submit any receipts for reimbursement.

The Alignment Problem

Some employers run their Health FSAs on a calendar year and renew their medical plans on another date - often July 1, but it could be any month after January. Let's use the example of July 1. In this case, an employee has participated in the general Health FSA for four months and continues to make pre-tax payroll elections and reimburse qualified expenses through the end of December.

When the employer introduces or renews an HSA-qualified medical plan effective July 1, that worker can't enroll and open a Health Savings Account or make or receive contributions to the account.

Why? Participating employees are locked into a Health FSA through the end of the plan year - even if they've already spent their full election or want to disenroll to open and fund the more flexible Health Savings Account. The exception is when they experience a qualifying life event like birth, adoption, marriage, divorce, or death. Unfortunately, wanting to enroll in a Health Savings Account is not a recognized qualified event under the federal tax code.

What the Employer Can't and Can Do

Employers can't fix this issue easily. They can't, for example, allow employees to disenroll mid-year. Nor can they allow employees who want to open and fund a health Savings Account to switch mid-year to a Limited-Purpose Health FSA, which reimburses dental and vision expenses only and doesn't disqualify a participant from opening and funding a Health Savings Account.

The company does have several tools at its disposal, but they're not ideal:

1. The company can terminate the general Health FSA as of July 1, 2022. That would create financial problems for individual participants, however. Those whose payroll deductions exceed their reimbursements forfeit those balances. Imagine, for example, an employee who faces a $1,000 inpatient deductible for a September maternity stay. The worker would fund the general Health FSA to the tune of $500 if the plan were cancelled mid-year. She could quickly spend the money on other expenses by June 30, 2022, but those aren't the services or items that she wanted to reimburse.
2. Turn the general Health FSA into a Limited-Purpose Health FSA effective July 1, 2022. That way, employees continue to make payroll deductions and reimburse qualified expenses. But the list of qualified expenses is restricted to qualified dental and vision services. This solution retains pre-tax payroll deductions, but the range of expenses is limited. And companies can't split the Health FSA plan mid-year and allow only employees who want to participate in the HSA program to switch to the Limited-Purpose Health FSA. It's an all-or-nothing proposition: Either all employees remain in the general Health FSA (and thus barred from opening or funding a Health Savings Account) or all are covered by a Limited-Purpose plan (and thus subject to a narrower range of qualified expenses).

These two options punish employees who had planned to spend their balances after June 30, 2022 (terminating the Health FSA) or had planned to spend their funds on medical services or qualified over-the-counter items (Limited-Purpose Health FSA. Those who feel the greatest financial pain are participants to are enrolled in another medical plan - including a spouse's or parent's - and aren't interested in opening or funding a Health Savings Account.

Employee Solutions That Work

Workers who understand the dilemma and want to open and fund a Health Savings Account can apply either of the following strategies:

1. Enroll in the HSA-qualified plan now and understand that they can't open or fund the Health Savings Account until Jan. 1, 2023. They can reimburse their qualified expenses from their Health FSA - though they made an election the prior November based on medical coverage with lower out-of-pocket costs. They can't adjust their Health FSA elections upward to compensate for this higher financial exposure.
2. Delay enrollment in the HSA-qualified plan for a year and remain on the other plan. Continue to reimburse qualified expenses from the general Health FSA through the end of the year, then don't re-enroll in the general Health FSA. Then face a six-month period with no Health FSA and no Health Savings Account until July 1, 2023, when they can open and begin to make their own and receive employer contributions to a Health Savings Account.

Employer Assistance

The company can make one key change to help these employees now and in the future. that solution: Run a short-year Health FSA effective the following Jan. 1 through June 30, 2023. Then, renew the Health FSA for 12 months to align it with the medical reimbursement. If the employer chooses, it can offer both a general Health FSA (for non-Health Savings Account participants) and a Limited-Purpose Health FSA (for employees enrolled in the HSA-qualified plan and can open and fund a Health Savings Account).

This move will eliminate the problem going forward. Beginning July 1, 2023, all employees will have the option to enroll in a 12-month Health FSA (either general or Limited-Purpose) that supports their medical-plan choice. If they're enrolled in the company's other plan, they still benefit, as they can adjust their new year's election to reflect any changes in cost-sharing in that plan. Under the current misalignment of benefits, employees can't increase their general Health FSA election if the company modifies its non-HSA-qualified plan to, say, raise the deductible by $1,000 or replace a $40 prescription-drug copay with 50% coinsurance capped at $100 out-of-pocket. Both changes increase enrolled employees' financial responsibility, yet they can't change a Health FSA election mid-year.

The Bottom Line

It almost always makes sense to run the Health FSA and medical plan years concurrently,* whether the company sponsors a Health Savings Account program or not. Adding one or two more decisions (a second if the employee also enrolls in the Dependent Care FSA) during open enrollment won't be a cranial-taxing event for employees. In fact, it will allow them to consider their elections in light of the medical cost-sharing in place for the next 12 months.

* The exception may be a school system that renews its medical coverage July 1. Teachers typically move on to new jobs in new districts during the summer. If the Health FSA renews July 1, departing workers could spend their full elections for the new year before departing, leaving the employer to foot the bill.

#HSAMondayMythbuster #HSAWednesdayWisdom #HSA #HealthSavingsAccount #TaxPerfect #yourHSAcademy #yourHealthSavingsAcademy