IRS Clarifies HSA-Health FSA Grace Period Connection
The IRS provided welcome relief and clarification this week related to the intersection between Health Savings Accounts (HSAs) and Health Flexible Spending Arrangement (Health FSA) grace periods. This is good and timely news for employers taking a first-time dip in the pool of Consumer-Driven Health Care (CDHC) next year.
IRS Notice 2005-86, released on Nov. 22, 2005 actually offers guidance on two important issues:
- Options available to employers who want to move from a Health FSA with a grace period to an HSA.
- Clarification on several questions relating to grace periods.
HSA-Health FSA Interaction
When IRS Notice 2005-42 modified the “use-it-or-lose-it” rule, it provided Health FSA plans the ability to carry over unused account balances for a grace period of up to two months and 15 days. This created a problem for employers who wanted to offer an HSA and a Health FSA grace period at the same time.
The problem is that a general-purpose Health FSA constitutes impermissible coverage that prohibits an individual from participating in an HSA. In Tuesday’s Notice, the IRS identified three arrangements (one available for a transitional time only) in which an individual can participate in both an HSA and a Health FSA grace period:
- The employer may amend its Health FSA to make it a limited-purpose FSA.
- The employer may amend its Health FSA to make it a post-deductible FSA.
- For plan years ending on June 4, 2006 or earlier, employers may have a general-deductible FSA and an HSA if:
- The individual is covered under a High Deductible Health Plan (HDHP) and does not have any other impermissible health coverage; and
- The individual has either a zero-balance on his/her Health FSA account or the employer amends the Health FSA to make the grace period unavailable for individuals who elect HDHP coverage.
If these rules are not applied, an individual who has coverage in a general-purpose Health FSA that offers a grace period will not be eligible to participate in an HSA until the first day of the month following the date that the grace period ends (e.g., for calendar-year plans extending the maximum 2½-month grace period: April 1).
Grace Period Clarifications
The IRS also confirmed its position on other issues related to the grace period. First, a grace period must be offered to all participants (including those on COBRA) who were covered by the Health FSA on the last day of the plan year. Second, an employee who terminates employment during a grace period is still eligible for the full amount of time of the grace period. Third, an employer may offer a grace period for some Cafeteria Plan benefit options (e.g., a Health FSA), but not others (e.g., a Dependent Care FSA). Finally, the maximum grace period ends on the 15 th day of the third calendar month after the month in which the plan year ends.
Additional Information
The Treasury Press Release is located at www.treas.gov/press/releases/js3022.htm. To view additional articles regarding the grace period, visit the Infinisource website at www.benefitsolved.com or review the following:
Additional information along with the ability to review what employers and employees can save with an FSA or HSA account is available by contacting Infinisource at 800-779-6384 or visiting the website at www.benefitsolved.com.
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