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| Posted on: Monday, February 5, 2007 |
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As part of the Tax Relief and Health Care Act of 2006, Health Savings Accounts (HSA) have become even more appealing and tax advantaged for those enrolled in a qualified High Deductible Health Plan (HDHP). The new rules provide new opportunities for HSA participants to build their accounts faster. While the Tax Relief and Heath Care Act of 2006 was signed into law in late December 2006 making the HSA improvements available to participants and plan sponsors for 2007, much needed IRS guidance and clarification of the new rules are expected in the next several weeks. Plan sponsors are wise to take a wait and see approach to some of the new rules to avoid any missteps in their implementation. However, for a general overview of the enhancements for your immediate use, please read on.
IMPROVED FUNDING OPTIONS FOR HSAs
Increase in annual contribution limit. In 2006, the HSA annual contribution limit was the lesser of the participant’s HDHP deductible or the statutory maximums. For 2007 this contribution rule goes away and instead, those with single coverage may contribute up to $2,850 per calendar year and those with family coverage, up to $5,650, regardless of their HDHP deductible. The catch up contribution limit for individuals age 55 or older remains unchanged (up to an additional $800 per calendar year may be contributed in 2007).
Full calendar year HSA contribution may be made by mid-year enrollees. Pre-2007, the HSA contribution maximums were pro-rated based on the number of months that an individual was enrolled in a qualified HDHP. Under the new rules, participants who enroll in a qualified HDHP mid-year are allowed to make the full maximum HSA contribution for the calendar year based on their coverage in December. For example, if an individual enrolled in a HDHP for family coverage in September and still had family coverage in December, she is eligible to contribute the family maximum $5,650 to her HSA that year. This revised rule alleviates the HSA maximum pro-ration headache that previously plagued mid-year enrollees, but does impose some additional sharp edges.
Caution: if an individual makes a full year HSA contribution as a mid-year enrollee, that individual must remain enrolled in a qualified HDHP for the 12 month period following the last month of the year. This is known as the Testing Period. Failure to maintain HDHP enrollment during the Testing Period (for reasons other than death or disability) will result in the individual paying income taxes and a 10% additional tax on contributions made for the months before the individual had HDHP coverage.
One-time transfer from IRAs to HSAs. The new rules allow for an irrevocable once in a lifetime, tax free, direct trustee to trustee transfer from an IRA into an HSA. The IRA transfer will not be included in income or subject to the IRA early withdrawal additional tax. Transfers count against the annual HSA maximum contribution permitted in the calendar year for which it is made. Transfers may not be made from SEPs or SIMPLE IRAs, and it is not clear at this time whether Roth IRAs are permissible (further IRS clarification should be forthcoming).
Caution: if an individual electing the one-time transfer does not remain an eligible individual during the Testing Period (the 12 months following the month of the contribution), the transferred amount is included in income and subject to a 10% additional tax.
Direct roll-overs from 2006 Healthcare FSAs and HRAs. A plan sponsor may amend their Healthcare FSA and/or HRA Plan Documents to allow roll-overs which are limited to one qualified HSA distribution per Healthcare FSA or HRA per individual. The amount rolled over may not exceed the lesser of an individual’s FSA or HRA balance on 9/21/06 or as of the distribution date.
Caution: we’d recommend waiting for additional guidance from the IRS on this issue before making Plan amendments.
IMPROVED EMPLOYER ADMINISTRATION FEATURES
Healthcare FSA grace period interaction. Coverage during a grace period for enrollees in a general purpose Healthcare FSA will be disregarded (effective for Plan Years beginning after 12/31/06). An individual will be eligible for HSA contributions during a grace period if the Healthcare FSA has $0 balance at the Plan Year end. Individuals with positive Plan Year-end balances will not be HSA eligible until the first day of the calendar month following the end of the grace period (even if the balance drops to $0 during the grace period).
Deadline for determining and publishing cost of living adjustments (COLA). Three HSA amounts are indexed for inflation using annual COLAs: 1) minimum deductible amounts (for 2007 they are $1,100 single coverage; $2,200 family coverage), 2) maximum out-of-pocket amounts (for 2007 they are $5,500 single coverage; $11,000 family coverage), and 3) annual HSA contribution limits (for 2007 they are $2,850 single coverage; $5,650 family coverage). Indexing will now be based on the 12 month period ending on March 31 and require that the IRS publish adjusted amounts for the upcoming calendar year by June 1 of the preceding year. This change will provide more time for employers to design qualified HDHP plans and for individuals to make decisions about their health care for the next year.
Allow greater employer contributions for lower-paid employees. Previously, employer contributions under the comparability rules had to be the same amount or percentage of the deductible for all employees with the same category of coverage. Consequently, employers could not contribute higher amounts to lower-paid employees. The new rules provide an exception to the comparability rules allowing employers to contribute more to the HSAs of non-highly compensated individuals. For this purpose, the definition of "highly compensated employee" is based on the same definition used for qualified retirement plans.
Recommended Plan Sponsor Action
With further IRS clarification on the new HSA rules expected in the coming weeks, plan sponsors of HDHPs may want to communicate the changes broadly to all HDHP enrolled employees, but proceed slowly in permitting any changes to current HSA employee contributions until additional concrete guidance is known.
Should you have any additional employee benefit questions or would like to discuss this material in detail, please don’t hesitate to call the Denman Team. |
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