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Can HSA-Ineligible Employees Still Receive HSA Distributions?

07.16.2019

Question: Our company currently offers a low-deductible major medical plan. We’re thinking of adding a high-deductible health plan (HDHP) as another option, so employees who choose the HDHP can establish and contribute to Health Savings Accounts (HSAs), assuming they otherwise meet the HSA eligibility requirements.

We’re concerned, however, about employees who establish HSAs and later become ineligible. For example, someone might enroll in our low-deductible plan during a future open enrollment. Can these employees still receive distributions from their HSAs?

Answer: Yes. Employees who switch from your HDHP to a low-deductible plan will no longer be eligible to contribute to their HSAs on a tax-favored basis (or have others contribute on their behalf). But they’ll still be able to receive distributions from their HSAs.

Only HSA-eligible individuals may contribute to HSAs or have their employers, family members or other individuals contribute to their HSAs on their behalf. Generally, individuals are eligible for HSA contributions if they:

  • Have qualifying HDHP coverage (that is, coverage that provides significant health benefits and meets statutory requirements for annual deductibles and out-of-pocket expenses),
  • Have no impermissible non-HDHP coverage,
  • Aren’t entitled to Medicare, and
  • Can’t be claimed as another person’s tax dependent.

While employees must be HSA-eligible individuals to make HSA contributions (or have contributions made by others on their behalf), they don’t have to be HSA-eligible individuals to receive HSA distributions. Thus, employees who switch from an HDHP to a low-deductible health plan can still receive HSA distributions.

If distributions are used to pay or reimburse qualified medical expenses, they’ll be tax-free. However, distributions for nonmedical expenses will be included in the employees’ gross income and will generally be subject to an additional 20% excise tax. The excise tax doesn’t apply to nonmedical distributions made after the employee reaches age 65, becomes disabled or dies.

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