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Mixing HSA and Medical FSA Can Spell Trouble for Employees

Health Savings Accounts (HSAs) and Medical Reimbursement Flexible Spending Arrangements (Medical FSAs) are excellent benefits. But taken together, they can create a trap for the unwary employee—disallowed tax deductions for contributions and a potential excise tax on those contributions.

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In fact, an employee can participate in both a Medical FSA and an HSA only if the FSA is set up as one of these:

  • A limited-purpose Medical FSA, limited to dental, vision, or preventive care expenses
  • A post-deductible Medical FSA that pays for medical expenses (that is, any coinsurance or copayments) after the deductible is met in a high-deductible health plan
  • A combination of a limited-purpose and post-deductible Medical FSA that pays for medical expenses after the deductible is met in a high-deductible health plan and dental, vision, or preventive care expenses

So, say your credit union offers an HSA as well as a limited-purpose or post-deductible Medical FSA. Or your credit union offers only an HSA and no Medical FSA at all. Or your credit union offers a Medical FSA but not an HSA. Under these plans, you might assume your employees couldn't fall into the aforementioned trap. But they still might.

An employee enrolled in your credit union's HSA also may participate in a spouse's Medical FSA at another employer, or an employee enrolled in your credit union's Medical FSA may have an HSA with a spouse's employer. If your employee uses the Medical FSA to get reimbursement for a charge applied to the deductible of the high-deductible health plan, your employee is barred from making an HSA contribution.

Extension Makes Things Trickier

The Medical FSA/HSA interplay became even trickier in May 2005. The IRS ruled that employers can grant employees an extension for incurring and submitting eligible expenses to their Medical FSAs. That extension can be as much as two and a half months beyond the end of the plan year.

But during that extension, the employee can't make contributions to an HSA unless:

  • The employer amends the Medical FSA during that period to make it either limited-purpose or post-deductible, or
  • The employee waives participation in the Medical FSA during the extension.

Educate Employees

Employees who fail to play by the rules for using Medical FSAs and HSAs together face consequences. They can't take tax deductions for any HSA contributions they shouldn't have made. Plus, if they haven't removed those contributions before filing income taxes, they'll face a 6% excise tax.

To avoid having employees get hit with nasty surprises during the next tax-filing season, educate them now about using Medical FSAs and HSAs properly. Work with your HSA vendor and Medical FSA third-party administrators to be sure that your plans are properly established to work together to get your employees their maximum benefit.

Elizabeth Myers is an employee solutions compliance manager for CUNA Mutual Group. This story first appeared on Added Dimensions, CUNA Mutual Group’s online publication for credit union leaders, at http://www.cunamutual.com/cmg/addedDimensions/home/0,1775,9057,00.html. Reprinted with permission.

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