Health savings accounts – which surpassed 18 million total accounts and held more than $34 billion in assets by mid-year 2016 – are expected to grab a prominent spot in President-elect Donald Trump’s efforts to reform the Affordable Care Act.

But with or without action from Trump or Congressional Republications, account providers predict substantial near-term HSA growth. The HSA investment consultancy Devenir expects the number of accounts to surpass 27 million by the end of 2018, with assets growing to more than $50 billion – projections which were made well before this year’s Presidential election.

Whatever becomes of Republicans’ efforts to repeal the ACA and replace it with more consumer-driven options, brokers must understand which voluntary policies comply with HSAs and qualified high-deductible plans, and which disqualify an HSA account holder from tax-exempt status.

To qualify for HSA tax exemptions, a participant and his or her spouse may not have any health coverage aside from an HDHP.

According to the IRS’ list of voluntary policy exemptions, “permitted” policies include long term care, vision, dental, accident and disability. Policies that cover specific illnesses or diseases qualify, as do those offering a fixed benefit per day (or other timeframe).

That explanation seems straightforward enough on its face, yet complications may arise when optional riders disqualify an exempted policy.

And if a broker inadvertently offers the wrong voluntary benefits and disqualifies a plan participant from HSA eligibility, he or she could expose employees to fines and tax exposure -- and create substantial headaches for employer clients.

Role of the ethical broker

There’s very little distinction between qualifying and disqualifying policies, says Paul Verberne, an attorney and principal with HSA Consulting Services LLC.

“The ethical broker needs to understand the differences as well as anyone,” says Verberne, who consults with banks and other HSA trustees, as well as brokers.

“A lot of voluntary policies have not been written with HSAs in mind,” he adds. “I don’t think there is rampant abuse in the market where brokers are selling voluntary products to HSA-qualified plans knowing that the policies will disqualify the participant. I’d say that, when it happens, it’s because of naiveté. It can be tricky — how many brokers are also tax specialists?”

How to spot a disqualifying rider/policy

To ensure that a voluntary policy doesn’t interfere with HSA participation, Verberne suggests a fairly simple initial test: If the voluntary policy covers anything the high-deductible plan would cover and is paid below the minimum deductible amount, there’s a good chance it will disqualify.

HSAs are granted tax benefits to offset the cost of high deductibles, explains Verberne. Those must be exhausted before high-deductible coverage kicks in.

When voluntary benefits pay for plan-covered services before the policyholder exhausts the deductible, the balance is disrupted between the tax benefits of HSAs and high-deductible plans.

To vet qualifying policies, says Verberne, the IRS applies a strict interpretation of tax code. This can be best understood through a 2007 private letter ruling the agency wrote in response to an employer that was concerned its voluntary benefit offerings could disqualify participants from HSA eligibility.

The package in question offered 11 cancer, critical illness, hospital indemnity, and accident voluntary policies alongside the high-deductible plan. The regulators broke these plans down one by one – along with any riders -- to determine which might negatively affect HSA participation.

Of the nearly 50 examples in the letter, regulators found one disqualifying voluntary policy and several disqualifying riders in other policies.

One plan that passed the IRS’ test was a group hospital indemnity policy that paid a specific benefit for a limited number of days in-hospital and another amount for a limited number of days in intensive care. But optional riders on the same policy -- including outpatient care coverage, surgical ER benefits and anesthesia coverage --were not considered permitted insurance, therefore triggering HSA ineligibility. Similarly, a voluntary accident policy that paid benefits for serious injury outside the workplace was permitted, but a rider paying a set amount for physician treatment was deemed disqualifying.

Broker is the best safeguard for participants

The problem with offering a disqualifying voluntary benefit is that participants usually continue contributing to their HSAs despite not being eligible to do so. They may not even know they’ve been barred from contributing to and withdrawing from their HSA until somebody tells them.

The thing is, the “somebody else” probably won’t be their HSA administrator or employer, as neither is required to verify that a plan participant is using his or her HSA within the confines of the IRS’ rules. And it may not be the carrier, either: Even though it’s in their best interest to help clients distinguish between qualifying and disqualifying voluntary benefits, they are not obligated to do so.

A plan participant could conceivably contribute to and withdraw from an ineligible HSA for years. And if they ever faced an audit, they might be on the hook for significant tax exposure and fines on any money distributed from the account.

Compliance ultimately falls on participants’ shoulders, says Verberne.

“HSA reporting is a lot like charitable giving,” he says. “It’s between you, the IRS and God.”

Plan sponsors have become more aware of the pitfalls, as it can be a massive headache to untangle a participant from a disqualified HSA and high-deductible plan. This can also seriously damage the reputation of the broker who sold the noncompliant policy.

The problem may only be exacerbated by the large numbers of carriers evolving as competition for voluntary consumers grow, with more than ever marketing HSA-compliant critical illness and indemnity policies.

For brokers needing to navigate the sometimes-murky world of HSA compliance, it would be smart to insist their carriers document which policy riders qualify for HSA accounts.  

“I’ve met some really sharp brokers over the years,” says Verberne. “They tend to be highly successful, often because they are out in front of technical compliance issues like this one.”