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Limited-purpose FSA to preserve HSA value

Many employers add a Limited Purpose Health FSA to their Section 125 Cafeteria plan as an additional benefit to employees with an HSA. These employees can use the LP FSA to preserve HSA funds for retirement.

Employers use the LP FSA to preserve HSA funds for employees to use for major medical out-of-pocket costs or in retirement.

How an HSA works

A Health Savings Account (HSA) accompanies a qualifying high-deductible health plan (HDHP) for the purpose of helping to pay eligible medical expenses not covered by the health plan. These out-of-pocket expenses include the higher deductible, co-pays, and co-insurance associated with the lower-cost HDHP.

When an HSA has a remaining balance at the end of a plan year, there is no use-it-or-lose-it rule like other health flexible spending accounts may have. That means employees can safely elect to contribute as much as they want each year, up to the annual contribution limit.

Related: Small Employer Benefits Affordable with HRA HSA HDHP


The balance in an HSA continues to grow through retirement, earning interest as well when deposited into an investment-based account. Then, in retirement, the HSA funds can be used to pay for eligible medical expenses (tax-free) or for anything the retirement-age owner wants to use it toward (without a 20% penalty).

This is why retirement advisers increasingly recommend the HSA to clients, and why employers are eager to help employees keep as much as possible in employer-sponsored HSA accounts.

Limited Purpose Health FSA to preserve HSA funds

A limited-purpose health flexible spending account (LP-FSA) works like the usual FSA exept that it is limited to covering qualifying dental and vision expenses for employees, spouses, and their eligible dependents.

By restricting LP-FSA reimbursements to dental and vision care expenses, HSA participants can have both a limited-purpose FSA and an HSA. This allows employees to maximize savings and tax benefits by extending the life of the HSA. Funds in the HSA are used to for major medical out-of-pocket costs or continue growing in the employee-owned fund until retirement.

Like any health FSA, an individual may deposit, through pre-tax salary deduction, up to the current annual contribution limit in a plan year. As dental and vision expenses are paid through the plan year, the employee is reimbursed by the LP-FSA.

Unlike the HSA, the LP-FSA has a use-it-or-lose-it-provision. Employees should carefully consider how much they will deposit each plan year for dental and vision expenses. At year-end, the employer may allow a grace period of up to 2-1/2 months or limit the rollover to $500. An employer may also choose to have no extension, meaning funds in the LP-FSA must be used by the end of the plan year or they are lost to the employee.

Related: Can employers add to employee Health FSA contribution?

LP-FSA employer costs and benefits

The up-front cost of adding the LP-FSA to an existing Section 125 plan is as low as $129.

For that one-time fee,  Core Documents provides employers with everything they need to establish an IRS- and DOL-compliant Section 125 with the HSA Savings module plan (electronically delivered in PDF format).


The employer must also consider ongoing adminstrative costs that include distributing a copy of the Summary Plan Document (SPD) with election forms, processing election forms, and making reimbursement when claims are submitted.

Fortunately, those costs are usually completely covered by employer tax savings.

8% employer tax savings

For every $1 an employee deposits into the LP-FSA, the employer eliminates about 8 cents in Social Security/Medicare (FICA) and other payroll taxes. When an employee contributes the maximum allowed, the employer saves around $200 in taxes. You can see how employer tax savings can quickly multiply with five, ten, twenty, and more employees.

Uniform Coverage

Uniform Coverage rules apply to all FSAs. This means the total annual amount the employee elects for the course of a year must be available to the employee for reimbursements on the first day of the plan year.

It sometimes happens that an employee will receive reimbursement early in the year that exceed contributions made and then leave the company. When it does, the employer has no recourse to recapture the funds. It cannot be held from the employee’s last pay, nor can it be requested of the employee in any other way.

To safeguard against this, some employers place a limit on the LP-FSA that is lower than the annual contribution limit allowed by law.

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