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Health Saving Accounts – Ramifications of Losing Eligibility

November 8, 2017

High-deductible health plans (HDHP) combined with a health savings account (HSA) are increasing in popularity in the employee benefits arena. It is a great way for employers (and employees) to reign in health insurance premium costs, as well as for employees to have a greater responsibility in the cost of their healthcare.

As more companies add an HDHP option to their employee benefits packages, it is increasingly important to let those know who are electing this option about HSA eligibility, and the ramifications of dropping or losing that coverage.

Employees who elect the HDHP option and establish an HSA have a nonforfeitable right to their HSA account balances, including their contributions, and any contributions made on their behalf by employers or family members. Employees will lose HSA eligibility should they switch to a non-HDHP option from their employer, or switch to a non-HDHP coverage under a spouse or partner’s plan.  However, their account balance will be unaffected.  Earnings on that balance will continue to accrue on a tax-free basis, payment distributions, or qualified reimbursable medical expenses will also continue to be tax-free.  HSA distributions made for other reasons will remain taxable, and may be subject to a 20% excise tax.

The main consequence of losing HSA eligibility is the effect on HSA contributions:

  • There is an annual limit on HSA contributions – it is based on the account holder’s actual eligibility, or deemed HSA eligibility from their employer.
  • An employee who is not HSA-eligible for a taxable year cannot exclude any employer contributions from income, and cannot deduct any other contributions for that year.
  • An employee who ceases to be HSA-eligible midyear may make or receive contributions only for the months of eligibility.
  • If the employee’s HSA has not already received the maximum contribution for those months when HSA eligibility ends, additional contributions could be made up to the applicable limit, provided that those contributions are made no later than the federal tax return deadline (without extensions) for the year of partial eligibility.
  • Contributions that are more than the maximum, or made after the deadline, are considered excess contributions that are neither excludable nor deductible. Excess contributions also may be subject to a 6% excise tax if they are not timely withdrawn.

And the last potential consequence, but not the least, to take into consideration is that certain special tax rules that are contingent on maintaining HSA eligibility for a 13-month “test period” will not be available. The test period requirement applies to employees who use the “full-contribution rule”, which can increase the contribution limit for individuals who become HSA-eligible, or switch to family HDHP coverage midyear, by allowing the annual contribution to be determined by the coverage in effect on December 1st.  It also applies to employees who make qualified HSA funding distributions (rollover from an IRA to an HSA). If HSA eligibility is lost before the applicable testing period ends, funds that were contributed or rolled over to the individual’s HSA will become taxable and may also be subject to a 10% additional tax.


For more information regarding High Deductible Health Plans (HDHP) and Health Savings Accounts (HSA) for your business, email Billy MacNair, Vice President at Brown & Brown Benefit Advisors,

Brown & Brown Benefit Advisors