Health Savings Account (HSA) Alert

New rules for Health Savings Accounts (HSAs) are in effect as of January 1, 2007. The new rules provide more flexibility for consumers and employers around HSAs. An

overview, followed by a more detailed summary, is provided below.

What’s New?

Major features of the new rules include:

• A one time transfer from an Individual Retirement Account (IRA) to an HSA is permitted.
• A one time rollover from a Flexible Spending Account (FSA) and/or Health
• Reimbursement Arrangement (HRA) to an HSA is permitted.
• The Health FSA grace period no longer impacts HSA eligibility, based on certain
• conditions.
• The maximum annual contribution limitations are no longer based on the lesser of
• the HDHP deductible or IRS limit.
• Contributions are no longer required to be pro-rated when an individual enrolls in an
• HDHP mid year under certain conditions.
• Cost of living adjustments will be based on the consumer price index and published
• by June 1 of the prior year the adjustments are effective.
• When employers contribute to an employee’s HSA (via the employee benefits
• program), they may make greater contributions outside of a Section 125 cafeteria
• plan for non-highly compensated employees without violating the HSA comparability
• rule.

Want More Details?

IRA Rollovers to an HSA

This rule allows for a one time tax-free trustee to trustee transfer of IRA funds into an

• HSA, provided certain conditions are satisfied.
• The amount contributed to the HSA is subject to the maximum annual
• contribution limits. For 2007, the maximum annual contribution limit is $2850 for
• single coverage and $5650 for family coverage. Amounts transferred from the
• IRA plus any additional employer or employee contributions will be applied
• against the maximum annual contribution limit.
• The individual must be covered by an HDHP and remain an eligible individual for
• 12 months after the transfer. If not, the funds transferred will be treated as
• taxable income and subject to a 10% excise tax.
• Traditional and Roth IRAs can be rolled over to an HSA.
• SEP and Simple IRAs are excluded from rollover.

Examples:

Sue has a single coverage under an HDHP and intends to contribute $2000 to her HSA. She also has an IRA with $800. Sue is able to roll her IRA funds into her HSA as the total of the two amounts does not exceed the maximum annual contribution limit of $2850. Jill has single coverage under an HDHP and intends to contribute $2850 to her HSA (2007 maximum annual contribution limit) through paycheck deductions. She also has an IRA balance of $1200. Jill is not eligible to roll her IRA funds into her HSA if she contributes $2850 (the maximum annual contribution limit allowed) from her paychecks. However, Jill can transfer funds from her IRA to her HSA, if she lowers her paycheck contribution to no more than $1650.

What are the benefits of this change?

Individuals now have the opportunity to supplement their HSA funds with IRA funds. This provides individuals with another source to help cover their out-of-pocket healthcare expenses.

FSA and HRA Rollovers to an HSA

This rule allows employers to permit a one time tax-free rollover of unused Health FSA and/or HRA balances to an HSA, provided certain conditions are satisfied.

• An employer allowing this rollover will likely need to amend their plan document and summary plan description.
• If an employer offers this option, all employees covered under the employer's HDHP must be given the opportunity to rollover funds to the HSA.
• The rollover must be the lesser of the amount in the FSA/HRA as of September 21, 2006 or the amount in the account at the time of distribution. Only employees who had the HRA and/or Health FSA on September 21, 2006 and through the time of distribution may make rollovers to their HSA. This rule does not apply to FSA/HRA accounts established after this date.
• The rollover must occur before January 1, 2012.
• The rollover must be sent directly to the HSA custodian by the employer.
• The individual must be covered by an HDHP for 12 months after the transfer. If not, the funds transferred will be treated as taxable income and subject to a 10% excise tax.
• The rollover to the HSA is not subject to the maximum annual contribution limits. This means rollovers from the FSA/HRA to the HSA will not reduce the maximum annual contribution to the HSA during the calendar year in which the rollover occurs.

Examples:

John has a Health Care FSA with a balance of $2000 on September 21, 2006. His employer’s renewal date is January 1, 2007. John’s Health FSA balance is $1500 as of December 31, 2007. The employer may only transfer $1500 (the lesser of the account balance on September 21, 2006 and the current balance) on the last day of the plan year. John’s coworker, Mary, also enrolls in a Health Care FSA. However, she joined the company on January 15, 2007. Since she did not have an FSA on September 21, 2006, she is ineligible to have funds transferred to her HSA. ACME offered an HRA to part-time and full-time employees in 2006. In 2007, ACME decides to offer an HDHP with an HSA and decides to allow employees to rollover unused HRA funds. ACME must allow all employees (full-time and part-time) to rollover the funds. ACME cannot only allow one class of employees to rollover funds.

What are the benefits of this change?

This rule eases the transition to HSA products for employers that offer HRAs to their employees. In the case of the FSA rollover, it allows employees to avoid the year end “use it or lose it” rule for the year of the rollover.

Grace Period Relief

Previously an individual who had an FSA with a grace period was not allowed to contribute to an HSA until the FSA grace period had expired. The new rule now allows an individual to establish or contribute to an HSA as long as he or she has either: (a) a

zero balance in the FSA on the last day of the plan year or (b) transfers the entire balance to the HSA as of the last day of the plan year. Rollovers for the FSA grace period are only allowed one-time.

Examples:

Bob participates in a calendar year Health Care FSA in 2006 with a 2 month grace period. Bob has a $0 balance on December 31, 2006. Under the new rules, Bob is eligible to contribute to an HSA on January 1, 2007. Kathy participates in a calendar year Health Care FSA in 2006 with a 2 month grace period. Kathy has a $1000 balance she transfers to an HSA prior to December 31, 2006. As a result, Kathy is eligible to contribute to an HSA effective January 1, 2007. Under the prior rule, Bob and Kathy would not have been eligible to participate in an HSA until April 1, 2007 (the beginning of the first full month following the end of the grace period).

What are the benefits of this change?

This rule makes it more attractive for an individual with an FSA grace period to move to a high deductible health plan with an HSA.

Elimination of Annual Deductible Limitations

Currently, an individual can contribute the lesser of the deductible or the annual maximum contribution limit. This scenario becomes even more complicated when the consumer has family coverage with an embedded deductible. In this situation, a special calculation has to be done to determine the maximum contribution. This rule simplifies contributions by eliminating the “lesser of” deductible rule by allowing

HSA contributions up to the maximum annual contribution without limiting the contribution to the individual’s HDHP deductible amount.

Examples:

Jim enrolls in single coverage under an HDHP on January 1, 2007 with a $1200 deductible. His plan year begins January 1, 2007 and ends December 31, 2007. Jim may contribute the maximum contribution limit which is $2850 for 2007. The prior rule would have limited his contribution to $1200, the amount of his deductible. Nancy enrolls in family coverage under an HDHP on January 1, 2007 with a $6000

deductible. Her plan year begins January 1, 2007 and ends December 31, 2007. Nancy may only contribute the maximum annual contribution limit allowed for family coverage, which is $5650.

Carol enrolls in family coverage under an HDHP on July 1, 2007 with a $6000 deductible. Carol’s plan year begins July 1, 2007 and ends June 30, 2008. Carol may contribute up to $5650, the maximum annual contribution limit for family coverage, between July 1, and December 31, 2007. Carol may then contribute the maximum annual contribution limit for family coverage for 2008 between January 1 and June 30,

2008. If she does, when Carol enrolls in an HDHP for the following plan year (July 1, 2008 thru June 30, 2009) she cannot contribute to her HSA from July 1, 2008 thru December 31, 2008 since she already contributed her maximum annual contribution limit. If Carol doesn’t choose to enroll in an HDHP for a full 12 month period after

December 31, 2007, she would be required to report any over-contributions as taxable income and would be subject to a 10% excise tax.

What are the benefits of this change?

By raising the amount individuals can contribute to their HSAs, this rule responds to the concern that many individuals must continue to pay coinsurance after meeting the deductible. Now individuals can contribute additional funds to cover these costs.

Mid-Year Enrollees

This rule allows full-year HSA contributions for individuals who enroll in an HDHP before the first day of December of any year, provided certain conditions are satisfied. This means, pro-ration of HSA contributions is no longer required based on the number of months covered by a qualified HDHP in the calendar year.

• Individuals who enroll in the HDHP at any time prior to December 1 can make a full-year contribution to the HSA that year.
• Individuals must be covered by a qualified HDHP and remain an eligible individual for 12 months after the end of the calendar year in which they enrolled in an HDHP.
• Individuals not covered by an HDHP for 12 months after the end of the calendar year in which they enrolled in an HDHP are subject to income tax and a 10% excise tax on HSA contributions for months not covered by an HDHP.

Examples:

Joe enrolls in family coverage under an HDHP on July 1, 2007, with a $6000 deductible. He may contribute the maximum annual contribution allowed for family coverage, which is $5650. However, if Joe contributes the full amount and fails to maintain qualified HDHP coverage for the remainder of the current taxable year (July 1, 2007 through December 31, 2007) and the following year (January 1, 2008 through December 31, 2008 in this example) he will be subject to taxes for the months he is not covered by an HDHP.  Under the prior rules, an individual on a calendar year plan with a $1200 annual deductible, who joined the plan in July, could only put $600 into the HSA. Due to pro-ration, he could only contribute half of the lesser of the deductible or maximum annual contribution amount. In addition, the full $1200 deductible had to be satisfied before the plan paid any benefits. This new rule fills that gap.

What are the benefits of this change?

The elimination of the pro-ration of HSA contributions responds to a concern that the HSA contributions were required to be prorated even though the individual had to satisfy the full HDHP deductible.

Cost of living adjustments (COLA)

This rule requires the Department of the Treasury to release the cost of living adjustments no later than June 1 of the prior year. This will give employers and administrators time to plan and communicate changes to participants and employers.

• COLA changes must be published by June 1 of the year prior to the year the adjustments are effective.
• The COLA modification will be based on the average of the Consumer Price Index for the 12-month period ending March 31 as opposed to August 31.

What are the benefits of this change?

This will significantly improve the employer’s ability to make decisions regarding benefits plan design or HSA contributions for the upcoming year in a more timely manner.

Comparable Contributions

This rule allows greater contributions for non-highly compensated (lower paid) employees without violating the HSA comparability rule for employer contributions made outside of a Section 125 cafeteria plan. Highly compensated employees typically have more than five percent company ownership during the current or previous plan year or have annual compensation of more than $95,000 (indexed for 2006) in the previous plan year.

• This ruling only applies to employer contributions made to the employee’s HSA outside a cafeteria plan.
• This will allow employers to contribute more to the HSAs of non-highly compensated employees without violating the comparability rule.
• Employers are already allowed to make greater contributions to non-highly compensated employees’ HSAs within the cafeteria plan. This rule now allows greater employer contributions to non-highly compensated employees outside the cafeteria plan.

Example:

The employer contributes $500 to Tom’s HSA. Tom is a full time employee with single coverage. Tom is also a highly compensated employee. The employer also contributes $700 to Rick’s HSA. Rick is also a full time employee with single coverage. However, Rick is a non-highly compensated employee. These conditions are permissible under the new rule for employers subject to comparability rules.

What are the benefits of this change?

Employers that do not maintain a cafeteria plan will be able to contribute more for lower income employees. If you have questions, you can contact Jim Milkey at (586) 445-8800.