New Legislation Makes HSA Easier to Use

Employee Benefits

On December 20, President Bush signed the Tax Relief and Health Care Act of 2006. The Act includes several significant health savings account (HSA) provisions, such as increases to the HSA contribution limits and administrative simplifications. The law appears to make HSAs more flexible and easy to use for employers and consumers.

Key changes to HSAs include:

• Increased HSA contribution limits;
• No contribution reduction for persons who join the high-deductible health plan mid-year;
• Consolidation of existing health reimbursement account (HRA) and flexible spending account (FSA) funds into HSAs;
• Elimination of the FSA two-and-a-half-month grace period problem;
• Earlier cost-of-living adjustments for HSA limits;
• Rollovers of existing IRS funds into HSAs; and
• Higher contribution limits for lower paid employees.

Frequently Asked Questions (FAQs)

What are the new maximum contributions for the HSA? In 2007, $2,850 for an individual coverage and $5,650 for family coverage, regardless of the plan’s annual deductible, as long as the plan is a qualified HDHP plan. Previously the HSA contributions were limited to the lower of the HDHP deductible or the maximum statutory amount.

Can employees change the amounts they have elected to contribute to their HSAs through pre-tax payroll deductions after open enrollment? Is an employer required to allow additional contributions via pre-tax payroll deductions?

• An employer can allow employees to change elections for pre-tax payroll deductions to an HSA on a go-forward basis. However, employers have discretion to limit the amount that an employee can contribute to an HSA through pre-tax payroll deductions. Accordingly, employers can, but are not required, to allow employees to change their pre-tax payroll deductions in response to the new law, which increases the HSA maximum contributions.
• If an employer decides not to allow employees to change their elections for pre-tax payroll deductions, they can make additional HSA contributions on an after-tax basis. Generally, it is preferable to allow HSA contributions through pre-tax payroll deduction so that employer and employee may benefit from possible FICA tax savings.

Can an employer contribute more to the HSAs of “non-highly compensated” employees? How is non-highly compensated defined?

• Under the new law, higher contributions – up to the statutory maximums - can be made for employees that are non-highly compensated without violating the comparable contribution rules.
• The comparable contribution rules, which generally require that employer contributions to an HSA be “comparable” for all participants do not apply to contributions that are made through a cafeteria plan.
• Most employers are making HSA contributions through a cafeteria plan and the HSA comparable contribution requirements do not apply.
• “Highly-compensated” employees are defined the same way as they are for 401(k) purposes. A “highly compensated” employee is any employee who was (1) a 5 percent owner at any time during the year or the proceeding year; or (2) for the preceding year, (a) had compensation from the employer in excess of $100,000 (for 2007) and (b) if elected by the employer, was in the group consisting of the top-20 percent of employees when ranked based on compensation. Non-highly compensated employees are employees not included in the definition of highly compensated employee.

What happens if an employee becomes eligible to contribute to an HSA mid-year? What is their maximum? Is it pro-rated?

• An individual who does not participate in an HDHP for a full calendar year can make a pro-rated HSA contribution. This is based on the months he or she is an eligible individual covered under an HDHP to avoid any risk of future penalties and taxes related to this provision.
• Alternately, the new law allows an individual who becomes covered by an HDHP for the first time after January 1 and who remains covered by an HDHP during the last month of the taxable year to contribute up to the full annual limit.
• However, if a mid-year HDHP enrollee makes a full-year HSA contribution, that individual must maintain HDHP coverage and continue to be an HSA-eligible individual during the 13-month period beginning with the last month of that year. Failure to maintain HSA eligibility (for reasons other than death or disability) will result in income tax and a 10-percent additional tax on the contributions amounts attributable to the months before the individual had HDHP coverage and was HSA eligible.
• Employers are not required to make contributions on their employees’ behalf. If they do, the new laws allow but do not require contributions up to the full maximum.
• HSA tax-advantages are largely built on the premise of individual accountability and responsibility. It is not yet clear what accountability the IRS expects the employers to have for confirming or ensuring that employees remain enrolled in the qualified HDHP for the full 13-month period.

Can account owners contribute funds from their IRA into their HSA?

• Yes, the IRS allows this to be done one time. This gives account holders access to IRA funds for HSA contributions. This amount, when combined with other HSA contributions for the year, is subject to the annual HSA contribution limit. As a result, contributions to the HSA from the IRA will count toward meeting theannual contribution maximum and will reduce other tax-advantaged contributions that the account holder could otherwise make.
• An individual with self-only coverage who transfers amounts from his or her IRA to an HSA may subsequently make an additional transfer if the individual switches to family coverage. The maximum amount of the additional transfer is equal to the difference between the amount transferred while the individual had self-only coverage and the maximum deductible limit for family coverage for the year.
• Failure to maintain eligibility for HSA contributions for 13 consecutive months, beginning in the month of the IRA transfer, for any reason other than death of disability would result in income tax and a 10 percent additional tax on the transferred amount.
• The IRA transfer might be a good option for individuals who have accumulated balances in an IRA but cannot otherwise afford to make the maximum HSA contribution this year. The HSA account has the added tax advantage for being tax free, even in retirement, as long as withdrawals are made for qualified medical expenses. It is recommended that employers and account holders consult with a qualified tax adviser for additional details.

Can employees who have an FSA with a grace period for the first two-and-a-half months of 2007 contribute to an HSA during the first three months of 2007?

• Under the new law, a participant in an FSA that incorporates the two-and-a-half month grace period may nonetheless contribute to an HSA during the grace period if his or her account balance is “zero” as of the end of the previous plan year.
• The employer and employee share responsibility for verifying that the FSA has a zero balance. As the plan sponsor, the employer has records for claims submitted and paid, and should share this information with the employee. Similarly, an employee should submit all receipts for medical expenses prior to the end of the plan year. If the employer and the employee think that the account has a zero balance as of the end of a particular calendar year but subsequently determine that it did not, the employee will be required to reduce his or her HSA contribution for the calendar year in which the two-and-a-half-month grace period was offered The employee will only be considered an eligible individual as of the first day of the month following the expiration of the two-and-a-half-month grace period.

Do employees have to spend down their FSA dollars by the end of the calendar year or the end of the grace period in order to make a full-year contribution to the HSA the following year?

The law specifies that the FSA must have a zero balance by the end of the calendar year in order for an individual to make a full-year contribution to the HSA the following year. The IRS may offer additional guidance on this issue.

Does an employer need to offer FSA/HRA rollover as an option for the employees?

No, an employer is not required to offer this as an option. Because HRAs and FSAs are employer-sponsored plans, the employer has the choice to offer the option to the employees.