Question: An employee enrolled in the HDHP but terminated from employment without ever establishing an HSA through the employer’s custodian. What happens to the HSA contributions for that employee?
Compliance Team Response:
Where an employee terminates employment prior to establishing an HSA through the employer’s custodian, the employer should refund all of the employee’s HSA payroll deductions as standard taxable income subject to withholding and payroll taxes. The employee will forfeit any employer contributions that would have been deposited if the employee had established the HSA.
This issue will also arise for employees who remain employed but have failed to establish an HSA for a significant period following enrollment in the HDHP. Best practice is to have a consistent policy in place to address situations for both active and terminated employees who do not take the steps required to open the HSA with the employer’s custodian.
Employee HSA Contributions
For employee HSA contributions, the employer must either deposit or return the employee’s salary reductions. Any reasonable administrative policy would be fine here. For example, failure to open the account within 90 days (or during the period of employment, if sooner) will result in a refund to the employee in the following payroll. That avoids the need to hold and potentially refund large amounts of employee contributions. Remember that any refund must be taxable income subject to withholding and payroll taxes.
Employer HSA Contributions
For employer HSA contributions, it is reasonable to have a consistent administrative policy providing that employees forfeit the employer contribution if they fail to timely open the account. For example, there will be no retro contributions beyond the last day of February of the following year. And if the account isn’t opened during the period of employment, all employer contributions are forfeited. The employer should provide employees with advance notice of the consequences of failing to timely establish the HSA.
Note that although IRS guidance does not directly address these types of policies generally, there are provisions in the comparability rules providing that employers may have a policy for employees to forfeit the employer contribution if they do not establish the HSA within a set period. Although most employers are not subject to the comparability rules (in almost all cases the Section 125 nondiscrimination rules apply instead), this provision at least provides a basis for the IRS approval of this type of approach generally.
Below is the IRS sample notice to employees (from the generally inapplicable comparability regulations) that can be modified to fit any employer’s policy in this respect.
For more information on the general nondiscrimination rules for HSAs, see our prior FAST addressing HSA Nondiscrimination Rules (Section 125 or Comparability).
For more information on the general contribution timing rules for HSAs, see our prior FAST addressing HSA Contribution Timing Requirements.
Treas. Reg. § 54.4980G-4, Q/A-14(c):
(c) Model notice. Employers may use the following sample language as a basis in preparing their own notices.
Notice to Employees Regarding Employer Contributions to HSAs:
This notice explains how you may be eligible to receive contributions from [employer] if you are covered by a High Deductible Health Plan (HDHP). [Employer] provides contributions to the Health Savings Account (HSA) of each employee who is [insert employer’s eligibility requirements for HSA contributions] (“eligible employee”). If you are an eligible employee, you must do the following in order to receive an employer contribution:
(1) Establish an HSA on or before the last day in February of [insert year after the year for which the contribution is being made] and;
(2) Notify [insert name and contact information for appropriate person to be contacted] of your HSA account information on or before the last day in February of [insert year after year for which the contribution is being made]. [Specify the HSA account information that the employee must provide (e.g., account number, name and address of trustee or custodian, etc.) and the method by which the employee must provide this account information (e.g., in writing, by e-mail, on a certain form, etc.)].
If you establish your HSA on or before the last day of February in [insert year after year for which the contribution is being made] and notify [employer] of your HSA account information, you will receive your HSA contributions, plus reasonable interest, for [insert year for which contribution is being made] by April 15 of [insert year after year for which contribution is being made]. If, however, you do not establish your HSA or you do not notify us of your HSA account information by the deadline, then we are not required to make any contributions to your HSA for [insert applicable year]. You may notify us that you have established an HSA by sending an [e-mail or] a written notice to [insert name, title and, if applicable, e-mail address]. If you have any questions about this notice, you can contact [insert name and title] at [insert telephone number or other contact information].
On the other hand, if the employer makes the payments for the health insurance directly to the insurer, then the payments are not included in the employee’s gross income. See Revenue Ruling 61-146, 1961-2 C.B. 25. This holds true even if the payments are routed through the employee to the insurer, as long as the employee’s right to dispose of the funds is not unlimited. However, if the employer makes health insurance payments directly to the employee with only an understanding that the employee will purchase health insurance with them, and there is no verification of or control over the purchase, that amount is included in wages for employment tax purposes and would be subject to FICA taxes. See Revenue Ruling 75-241, 1975-1 C.B. 316.
Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).