By: HUB’s EB Compliance Team

In part, due to the COVID-19 pandemic, some employers are exploring opportunities to allow employees to use their unused health flexible spending arrangements (“health FSAs”) funds from 2020. There are essentially two options for employers that want to allow employees to use their leftover FSA in the following plan year: (1) grace periods; and (2) carryovers. However, sponsors of high deductible health plans (“HDHPs”) should keep in mind how these two different rules interact with health savings accounts (“HSAs”).


HSAs are tax-favored, IRA-type accounts that can be contributed to by, or on behalf of, “eligible individuals” who are covered by HDHPs. Because an HSA is a savings/IRA-type account, employees can accumulate dollars in the account and carry them over year after year. HSA funds may be used to pay for certain qualified medical expenses on a tax-free basis. However, to establish or contribute to an HSA, the individual cannot be covered under any other health plan that is not an HDHP.

By contrast, a health FSA is a tax favored account that reimburses qualified medical expenses and is a type of group health plan. Unlike HSA’s, FSA’s generally require employees to use all of the funds within the plan-year. There are two kinds of FSAs:

  1. Limited Purpose/Limited Scope FSA: These limited purpose health FSAs will only reimburse for permitted expenses (dental and vision, for example) or expenses after the HDHP deductible is reached and are HSA-compatible.
  2. General Purpose FSA: An FSA that reimburses for all health care expenses and therefore is not HSA-compatible.

An individual who is covered by a “general purpose” health FSA is not eligible to participate in an HSA because they have non-HDHP coverage. Because HSA eligibility is determined monthly, this restriction generally applies for any month the individual is covered by the health FSA and usually not just for the months when an individual has FSA money available for reimbursement. For example, Julio is in a general purpose FSA which is based on the calendar year (January through December) and does not have a grace period or carryover. However, Julio spends all of his FSA money by June. Julio will not become HSA-eligible in July. Instead, Julio may become eligible for an HSA in the following plan year if Julio enrolls in the HDHP.

What happens if Julio’s general purpose FSA instead has a grace period or a carryover into 2021?   

Grace Periods

A grace period is an extended period, up to 2 ½ months, after the end of the plan year. During this grace period, employees may use amounts contributed in the prior plan year to pay for current year expenses. For example, if Julio had leftover funds in 2020 and his employer offered a grace period, he could use those funds to pay for qualified medical expenses through March 15, 2021. This gives Julio extra time to use any unused funds.

But what if during open enrollment Julio changed to the HDHP effective January 1, 2021 and he wants to contribute to an HSA? Julio will not be able to contribute to the HSA in the first quarter of the year if he has money in his general purpose FSA account in January 2021. Because Julio has funds in his general purpose health FSA during the grace period, under IRS rules, Julio cannot contribute to the HSA (or receive employer contributions to the HSA) until April 1, 2021 (after the grace period expires). Because HSA eligibility and contributions limits are determined on a monthly basis, this means that Julio could potentially miss one quarter of the HSA contribution limit for the year.

The IRS has said the grace period must be either limited purpose or general purpose for all employees. Converting to a limited purpose grace period for all employees could be seen as harmful by those employees that do not move to the HDHP plan. This makes the design choice for the employer very difficult.

What if Julio exhausted all of his FSA dollars before the end of 2020? Could he contribute to the HSA beginning on January 1st, 2021 (the effective date of his HDHP)? The answer is yes!  This is a rare exception to FSA/HSA rule. An employee with a zero balance at the end of the general purpose FSA plan year may become HSA-eligible on first day of the new plan year. To continue with Julio’s example, this means that on January 1 Julio may contribute to the HSA since he enrolled in the HDHP effective on January 1, 2021. While this is helpful, it partially defeats the purpose of adding a grace period since it is designed to help employees who have unused funds at the end of the year.  

By contrast, employees that achieve a zero-dollar FSA balance during the grace period (which occurs after the end of the plan year), will remain ineligible for the HSA until the first of the month after the grace period is over (April 1st, in our example). This side effect of a general purpose grace period is somewhat reduced by the so-called HSA “full contribution” rule.  In short, this rule generally says an employee in an HDHP (and not covered by other disqualifying coverage) on December 1 of a calendar year may make the full contribution to the HSA for that calendar year. However, if the employee loses HDHP coverage or otherwise becomes disqualified within the following 12 months, then some portion of the “make-up” contributions they make will be treated as excess contributions. Generally speaking, excess contributions are subject to excise taxes until they are withdrawn, creating significant tax headaches for the employee.


Instead of a grace period, what if Julio’s FSA allowed a carryover at the end of 2020? This would mean that instead of a grace period, Julio may carryover up to $550 (or a lower limit specified in the plan) to the new plan year (in Julio’s example, 2021). The $550 will be adjusted for inflation annually, as discussed in our earlier post hereFor example, if Julio elected $2,000 in the health FSA in 2020, but was only reimbursed $1,500 for 2020, Julio could use the remaining $500 for FSA qualified medical expenses in 2021.

What if Julio’s FSA allowed a carryover into 2021 and Julio enrolled in the HDHP effective January 1? Can Julio contribute to the HSA beginning on January 1st, 2021? A general purpose carryover would make Julio ineligible to contribute to (or receive employer contributions to) the HSA for the entirety of 2021. Fortunately, however, the IRS provides some flexibility. There are a few different options:

  1. The plan may allow the participant to choose to convert the carryover funds to a “limited purpose” carryover (see explanation of a “limited purpose” FSA above).
  2. If the employer sponsors both a general purpose FSA and a limited purpose FSA, then the employer can automatically convert the carryover funds to “limited purpose.”
  3. The employer can allow employees to waive and forfeit the carryover amount.

The downside of the carryover is that, unlike the grace period, there is a limit on the funds that can be used in the following year. Therefore, employers may want to review forfeitures in prior years to determine whether a carryover or grace period is a better fit, if they do not already have one.

Practical Considerations

In addition to choosing to offer either a grace period or carryover, employers should keep the following in mind:

  • An employer may offer either a grace period or a carryover (or neither), but not both.
  • An employer that is interested in adding a grace period or carryover (or to switch from one to the other) must amend their plan documents by the end of the plan year to add it.
  • In adopting either of these, the employer will need to make some other design decisions. For example, will unused funds first be used to pay prior year expenses or current year expenses?
  • The employer should also confirm their health FSA administrator can handle the grace period or carryover (including any design decisions they make). There are other eligibility rules for these extended periods that employers also need to consider.
  • Apart from the HSA-interaction issues, be sure to communicate these offerings as part of open enrollment. Knowing that they may have some leftover funds available will impact the employees’ contribution decisions for the next plan year.

If you have any questions, please contact your HUB Advisor. You can also view more compliance articles in our Compliance Directory.


The information herein is intended to be educational only and is based on information that is generally available. HUB International makes no representation or warranty as to its accuracy and is not obligated to update the information should it change in the future. The information is not intended to be legal or tax advice. Consult your attorney and/or professional advisor as to your organization’s specific circumstances and legal, tax or other requirements.