March 14, 2005
HSA Reimbursement of Continuation Coverage
Distributions of HSA funds are “tax free” only if attributed to qualified expenses.
General Rule
Insurance premiums (including premiums for self-insured coverage)
are not a qualified expense.
Exception. One of the exceptions to the general rule provides premiums for continuation coverage required by federal law are considered qualified expenses. We have received informal guidance from the IRS regarding the possible application of this exception to continuation coverage required by state law.
In general, to the extent the continuation coverage required by state law is coextensive with federal COBRA coverage, the premiums for that coverage will be considered qualified expenses. However, to the extent the state continuation requirements are more generous than the requirements under COBRA (i.e., not coextensive), the premiums for the more generous state coverage will not be a qualified expense.
As a result of this rule, premiums for most state-based continuation coverage following termination of employment will be considered a qualified expense. In the non-retirement context, state continuation and COBRA coverage will be coextensive. However, with respect to retiree coverage required by Minnesota Statute Section 471.61, only the premiums for the first 18 months following retirement would likely be a qualified expense. During this time period, the retiree coverage would be coextensive with COBRA. Premiums for coverage beyond that time period required under state law would not be qualified expenses; the coverages would not be coextensive.
There are other situations where the premiums will not be qualified expenses because the continuation coverage under state law will not be coextensive with COBRA coverage. The most obvious circumstances are where there is no applicable federal continuation. For example, under the Minnesota law providing continuation coverage to spouses of police officers and firefighters killed in the line of duty, if the spouse was not covered prior to the employee’s death, there would be no COBRA coverage, only state continuation coverage. In this situation, the continuation premiums would not be qualified expenses because there is no COBRA with which to be coextensive.
Consideration. Although an employer has no obligation to review or otherwise adjudicate HSA expenses, the scope of eligibility of continuation coverage premiums may be a factor relevant to whether a governmental entity adopts a high deductible health plan and makes HSA contributions. At the very least, it may impact the way in which the program is communicated.