Understanding health spending account rollover rules in Canada

Introduction

Health Spending Accounts (HSAs) offer a flexible and cost-effective way for businesses in Canada to provide health benefits to their employees. However, to ensure these accounts are used effectively and in accordance with Canada Revenue Agency (CRA) guidelines, it’s important to understand the rules surrounding HSA rollovers.

Incorporating Risk to Qualify

A fundamental requirement for an HSA to qualify under CRA rules is the inclusion of an element of risk. This is achieved by setting a spending or benefit limit that must be utilized within a designated timeframe. If an HSA were to allow benefits to accumulate indefinitely without any stipulated annual limits, it would not meet the CRA’s requirement for a reasonable element of risk. Consequently, the HSA would not qualify as a private health services plan, and the benefits paid from it would be taxable to the employee.

Rollover Mechanism Explained

For a typical HSA, each employee category is allocated a specific spending limit per plan year. Depending on the plan, unused credits or unclaimed expenses can be carried forward for up to 12 months, into the next plan year. By the end of that second plan year, any funds from the first year that remain unclaimed are forfeited. It’s important to note that forfeited funds can’t be paid out to the employee; depending on how the plan is funded, they stay with or revert to the employer.

Practical Examples

Small Business Scenario (i.e. with employees):

• Consider a small business with five employees, including the owner.
• The owner allocates $10,000 for themselves, $5,000 for a manager, and $2,500 for each of the three full-time employees annually through the HSA.
• If the manager spends only $3,000 in the first year, the unclaimed $2,000 rolls over, giving them a $7,000 limit for the next year.
• Should the manager not utilize this rollover amount, it is forfeited after the second year, although the funds remain with the employer.

Self-employed & Incorporated Professional Scenario:

• An incorporated professional, aged 45, with a spouse and two children, allocates a $15,000 annual limit for their HSA.
• After spending $5,000 in the first year, the remaining $10,000 rolls over to the next year, combining with a fresh $15,000 allocation, so in the second year this professional will have an aggregate limit of $25,000.
• If, in the second year, $8,000 is claimed, the $2,000 from the first year that wasn't used is forfeited.
• The professional then starts the third year with a potential $30,000 available, combining the new year's allocation ($15,000) with the unspent amount from the second year ($15,000).

Benefits for Small Business Owners

HSAs offer small business owners a cost-effective way to pay for eligible health and dental expenses, either instead of or alongside a traditional health insurance plan, and they are straightforward to manage. Understanding and following the rollover rules set by the CRA helps small businesses get the most from HSAs for their employees while remaining compliant with tax rules.