By Rob Thurston and Anamaria Szekely
You probably have read more about Health Savings Accounts (HSA s) than any other new benefit in the last 15 years.
An HSA is a tax-favored account designed to pay for certain medical expenses and allows for a build up of savings to pay for future medical expenses. TheHSA s give individuals and/or employees a way to fund their health expenses now and save for retirement later.
The Treasury Department and The IRS have issued ten rulings and announcements in the last year and on 07/23/2004 have released Notice 2004-50 on the use of Health Savings Accounts. Harry Beker of the IRS has suggested on September 24, 2004 that further rulings and even Regulations will be released shortly.
The previous IRS guidance to address these issues included:
- Notice 2004-2 (general overview of HSA s)
- Notice 2004-23 (safe harbor definition of preventive care)
- Notice 2004-25 (transition relief allowing establishment of 2004 HSA as late as April 2005)
- Rev. Rul. 2004-38 (defines scope of other permissible non-HDHP coverage)
- Rev. Proc. 2004-22 (transition relief from Rev. Rul. 2004-38 for prescription drug plans offered under separate plan until January 1, 2006)
- Rev. Rul. 2004-45 (addresses the scope of permissible Health FSA /HRA coverage maintained by an eligible individual)
- Sample Trust/Custodian documents
- Notice 2004-43 (transition relief for plans in states that cannot qualify as HDHP due to state laws until January 1, 2006)
- FAB 2004-1 [EBSA/Department of Labor] (outlines rules for determining whether HSA is subject to ERISA)
According to Treasury, Notice 2004-50 will "help providers to establish HSA s and consumers to enjoy their benefits". But employees are still confused and struggling to understand if they should implement an HSA now or wait.
With all this information from the IRS many employers are literally "overwhelmed". Employees are generally facing one of three choices if they want to truly understand HSA s:
- Hire an attorney to clarify the law.
- Pay a consultant to find the best HSA available and go with that recommendation/ information.
- Take the time and effort to become educated by reading articles (like this one), attending seminars/ teleconferences, and subscribing to online/written educational services.
In this article we are trying to address some that weren't interpreted clearly or were lacking clarification. This article follows closely the 88 Q&As found on Notice 2004-50 released by the Treasury Department and the IRS on 07/23/2004.
If you would like to have the Notice in front of you when reading this article we recommend the following link:
Highlights include clarification that:
- "Benefits under Employee Assistance Plans, Disease Management Plans and Wellness Programs generally do not disqualify an otherwise eligible individual from contributing to an HSA .
- Mistaken distributions from an HSA can be repaid to an HSA without penalty or tax.
- Generally, the FSA -type salary reduction rules do not apply to HSA salary reduction contributions, which generally follow the more flexible 401(k) type rules which allow changes in elections throughout the year as long as any election is effective prospectively).
- Payments by individuals due to traditional benefit limits that are part of reasonable plan designs do not count against the out-of-pocket maximums.
- Employer matching contributions made through a cafeteria plan are not subject to the comparability requirements.
- Account fees paid from HSA s are nontaxable distributions; account fees paid outside of the HSA directly to trustees are not treated as contributions. " - HSA Market Update Audioconference- Ashley Gillihan, July 27, 2004
An HSA can only be established by or on behalf of an eligible individual. The question would be - who is an eligible individual? In order to be an eligible individual, that employee must be covered by a high-deductible health plan.(HDHP). Many employers offer employees a choice of several health plans, including HDHPs and non-HDHPs. In this situation, if the employee chooses the HDHP is he eligible? Yes, according to the Notice, because what matters for purposes of determining eligibility is the choice and not the options. (Q/A-1)
What about those individuals eligible for Medicare? If they are just eligible and not enrolled in Medicare Part A or B, they can continue to fund an HSA and make additional catch-up contributions from age 55-65. Once they enroll in Medicare they loose their eligibility. (Q/A-2, 3)
Some other issues included in this section are the eligibility under TRICARE, under HDHP and permitted insurance , participation in first Dollar EAPs, disease management, and wellness programs. Let's discuss them one by one.
If an individual is receiving health benefits under TRICARE he is considered ineligible individual because the coverage options under TRICARE do not meet the minimum annual deductible requirements for HDHPs. (Q/A 6)
A welcomed explanation concerns those individuals covered by an HDHP and by permitted insurance for one or more specific diseases, including cancer, diabetes, asthma, or congestive heart failure. This individuals are eligible "as long as the principal health coverage is provided by the HDHP." (Q/A 7) In order to be considered an eligible individual , an employee must be covered by an HDHP at the beginning of the month. An employee that first becomes covered by his or her employer's HDHP on September 15 is not eligible to establish or fund an HSA , until October 1.
What about participation in first Dollar EAPs, disease management, and wellness programs? Will they disqualify an otherwise eligible individual? According to Q/A 1- they won't as long as they "do not provide significant benefits in the form of medical care and treatment." This question is supported with a series of examples.
Out of pocket maximum
As far as the employer statutory limit on out-of-pocket expenses for HDHPs goes, here are the clarifications that Notice 2004-50 have provided.
"In general, a health plan does not qualify as an HDHP unless it limits annual out-of-pocket expenses for covered benefits to $5,000 for self-only coverage and $10,000 for family coverage. (These are the limits for 2004 only; the limits will be adjusted annually for inflation.) The Notice defines "family coverage" as any coverage other than self-only coverage. (Q/A 12) "- Latest and for a Time Last - Round of HSA Guidance-, Washington Bulletin, Deloitte, July 26,2004
When we speak about health plans there are lifetime limits on all benefits, as well as annual or lifetime limits on specific benefits. Q/ A- 14 clarifies the fact that having a reasonable lifetime limit does not cause a plan to violate out -of- pocket expense limits. An example given in the Notice suggest that $ 1 million is a reasonable limit.
"Plans may limit benefits to usual, customary, and reasonable (UCR) amounts. These are reasonable restrictions on benefits, and thus amounts covered individuals pay in excess of UCR that are not paid by the HDHP do not count against the out-of-pocket maximum. (Q/A 16)"- " Treasury Guidance Clears Much Confusion on HSA Issues"- Hickman and Gilihan, ECFC,2004-20
"As a general matter, an HDHP must limit out-of-pocket expenses either by design or by its express terms. The HDHP need not state an express limit if it is not necessary to prevent participants from exceeding the out-of-pocket maximum. (Q/A 17) For example, an HDHP with a $2,000 deductible for self-only coverage that pays 100 percent of covered expenses above the deductible does not need an express limit on out-of-pocket expenses." Washington Bulletin, Deloitte, July 26 2004
"The Notice provides extensive guidance on certain specific issues relating to the HDHP definition. Of particular interest to employers, this section clarifies that an employer switching from a non-HDHP to an HDHP in the middle of the year can provide a credit against the HDHP deductible for unreimbursed expenses employees incurred during the previous health plan's short plan year. (Q/A 22) This may be an important consideration for employers that otherwise might not want to switch their employees to an HDHP in the middle of the year.
The Notice also explains the rules for calculating the minimum deductible for an HDHP when the period for satisfying the deductible is longer than 12 months (Q/A 24), and clarifies that HDHP participants can take advantage of any plan-negotiated discounts from providers even if they have not yet satisfied the deductible (Q/A 25). "Washington Bulletin, Deloitte July 26,2004
Preventive Care (Treatment and Drugs)
Let's talk about preventive care service or screening that includes treatment of a related condition. Q&A-26 suggest that where it would be unreasonable or impractical to perform a separate procedure to treat a condition discovered during a preventive screening, any such treatment that is incidental to the screening is considered preventive care. For example, removal of polyps during a diagnostic colonoscopy is preventive." - Mark Wincek- Legal Alert- Notice 2004-50: A Summer Tsunami of HSA Guidance (But WillEmployers Be Interested?), July 27, 2004
Can drugs constitute preventive care as defined by Notice 2004-23? "Yes, if the drug satisfies two conditions: The drug is taken by an individual who has developed risk factors for a disease that has not yet manifested itself or not yet become clinically apparent; or to prevent the recurrence of a disease from which a person has recovered The rule appears to apply to both over the counter and prescription drugs."According to the Notice, "drugs or medications are preventive care when taken by a person who has developed risk factors for a disease that has not yet manifested itself or not yet become clinically apparent (i.e., asymptomatic), or to prevent the reoccurrence of a disease from which a person has recovered." (Q/A 27) . Such drugs could be cholesterol lowering medications or drugs that are treating recovered heart attack or stroke victims with Angiotensin-converting Enzyme (ACE) inhibitors to prevent a reoccurrence.
Contribution to the HSA
Tax- favored HSA contributions may come from four sources: the eligible individual, the eligible individual's employer, any other person or a rollover contribution from another HSA or MSA. Contrary to the language in the statute, the guidance indicates that any person, regardless of family status, can make tax favored contributions to an HSA for an eligible individual. (Q-28)
Here is the way that this contribution can be made:
A husband and wife may divide HSA s any way they wish. If they do not stipulate a specific division of the HSA , it will be made equally between the two persons (Q/A 32). An HSA holder can withdraw excess contributions to theHSA before year end and avoid the 6 percent excise tax on the excess, but the holder also must calculate and distribute earnings on the excess, using the rules for calculating income on excess IRA contributions. (Q/A 34). HSA holders withdrawing amounts for nonmedical expenses will be subject to income tax on those amounts and, unless the withdrawal is due to death, disability, or Medicare eligibility, there is a 10 percent withdrawal penalty. (Q/A 35).
Q&A-31 clarifies "that the maximum HSA contribution for a married couple with family HDHP coverage is the lesser of: (1) the lowest HDHP family deductible applicable to the family, or (2) the statutory dollar maximum ($5,150 for 2004). If we assume two HDHPs that are designed in compliance with the statutory maximum, the HDHP with the lower family deductible will establish the contribution limit for the couple, and this may be divided between them as they choose." Wincek- Legal Alert- Notice 2004-50: A Summer Tsunami ofHSA Guidance (But Will Employers Be Interested?), July 27, 2004
Distributions from an HSA are generally excluded from an account beneficiary's gross income to the extent the distributions are for qualified medical expenses as defined by Code 213 (d). HSA funds can also be withdrawn for non-medical reasons but these distributions are includable in gross income and generally subject to an additional 10% exercise tax.
Distribution clarifications generally are generous.
The HSA holder may pay for spouses' or dependents' medical expenses, regardless of whether the spouses or dependents are covered by HDHPs, but such expenses cannot be reimbursed more than once. (Q/A 36, 38)
It would be nice and a lot of people wondered whether HSA s could be used as savings vehicles by deferring when nontaxable benefit reimbursements are received . Q&A-39 permits HSA s to be used for this purpose.
According to the Q& A- 40 HSA distributions may pay/reimburse long-term care insurance premiums, even if the distributions derive from amounts contributed by salary-reduction.
Individuals age 65 or older and eligible and enrolled in Medicare may use theHSA to pay for Medicare premiums (including reimbursing the payee for premiums withheld from Social Security payments) and the retiree's share of employer-provided health care costs. Individuals under age 65 and covered by Medicare for end-stage renal disease or disabled cannot use the HSA to pay for Medicare or other medical premiums. (Q/A 43-45)
HSA compatibility with other plans
"The rules for employer-paid HSA contributions seem rather strict. An employer match of the employee's contribution does not necessarily satisfy the comparability rule, nor would an age-based contribution or contributions based on participation in a wellness, disease management, or similar program. If the employer contributes to an HSA for any employee enrolled in the employer's HDHP, the employer must contribute a comparable amount for all employers in the employers HDHP. Likewise, if the employer contributes to an HSA for an employee enrolled in any HDHP, the employer must contribute to the HSA s of all such employees. Contributions can be based on a month to month basis, thus employees working less than 12 months can be treated differently than those working the entire year. After tax employee contributions are not subject to the comparability rules. (Q/A 46-54)
Q&A-47 provides that matching contributions to an HSA will not violate the comparability rule if they are made through a cafeteria plan. This is a terrific result. Functionally, it appears to allow employers to do matching contributions exactly as they desired, so long as they maintain a cafeteria plan, which today is pretty standard. In other words, the matching contributions may go directly into the HSA , rather than just being additional employer credits that may be used for benefits under the cafeteria plan. In effect, this is like when an employee pays $100 per month under a cafeteria plan and receives in return health plan coverage worth $400 per month (the employer effectively matches the employee's contribution in paying for the health plan). With the HSA , the employee will make a salary reduction contribution under the cafeteria plan to the HSA , and then will receive in return increased funding for the HSA as a result of the same kind of match through the cafeteria plan.
Q&A-48 holds that employer contributions to an HSA conditioned on an employee's participation in health assessments, disease management programs or wellness programs violate the comparability rule, unless all eligible employees actually receive comparable contributions. However, here again, the employer can accomplish the same goal by offering through a cafeteria plan an HSA contribution that is subject to an election of cash. "-Wincek- Legal Alert- Notice 2004-50: A Summer Tsunami of HSA Guidance (But WillEmployers Be Interested?), July 27, 2004
Rollovers Among HSA s
Rollovers among HSA s is a hot topic in the Notice 2004-50. (Q/A 55-56) makes it clear that only one rollover per year is permitted if the account holder receives the HSA amount and rolls it to a new HSA ; however, trustee to trustee rollovers are unlimited.
Cafeteria and HSA s
Do the cafeteria plan rules apply to HSA contributions made through a cafeteria plan? There are three key requirements that apply to health flexible spending arrangements (health FSA s)but do not apply to HSA s:
- The prohibition on carrying over unused elective contributions or plan benefits from one plan year to another plan year;
- The level coverage rule, which requires the maximum amount of reimbursement to be available at all times during the coverage period; and
- The 12-month period of coverage rule, which is intended to bar employees from participating only when they need coverage. ( Q&A- 57)
Q&A-58 clarifies the contribution to HSA s made by employee and employer. Employees who elect to make HSA contributions can start, stop, increase or decrease elections at any time, so long as the elections are prospective only. (In other words, the cafeteria plan election rules for HSA s follow the "401(k) model.") Employers are allowed to impose restrictions on HSA contribution elections under cafeteria plans, but such restrictions must apply uniformly to all employees.
"An employer can add an HSA as a new cafeteria plan benefit mid-year, and employees can prospectively elect the HSA . However, Q&A-59 cautions that Treas. Reg. § 1.125-4 election restrictions typically will prevent an employee from changing a health FSA election (health FSA elections may not be changed in connection with the "addition or improvement of a benefit package option"). Therefore, an employee who has elected coverage under a typical, general-purpose health FSA usually cannot be an "eligible individual" under Rev. Rul. 2004-45 (unless, for example, the employee has already exhausted the FSA ). One possible work-around may be to leave the dollar amount of the employee'sFSA election unchanged, but for the employer to amend the FSA plan to provide that it will only pay benefits as permitted by Rev. Rul. 2004-45 for any employee who elects to fund an HSA . Because the FSA election is unchanged, this arguably could work, but the IRS may treat the amendment as indirectly effecting an impermissible change. In addition, the overlapping FSA issue could also arise with a spouse's health FSA , where the employer has no control. "Wincek- Legal Alert- Notice 2004-50: A Summer Tsunami of HSA Guidance (But WillEmployers Be Interested?), July 27, 2004
How do we do HSA administration? (Q/A 62-71) An HSA may be invested in any investment approved for an IRA. For example, bank accounts, stocks, mutual funds and certain bullion and coins are acceptable, but life insurance contracts and collectibles (e.g., antiques) are not. Spouses cannot have jointHSA s, but individuals can have as many HSA s as they wish. HSA s can be held in a common trust or investment fund. Any administration or account maintenance fees paid directly by the account beneficiary (or employer) do not count towards the annual maximum HSA contribution limit. On the other hand, if fees are withdrawn from the HSA , the maximum limit is not increased, and thus part of the contribution limit can be used up paying fees.
Duties and Limits on Trustees and Custodians
Can the employer and/or trustee restrict distributions from the HSA in any way? - This is probably the major road back of the Notice 2004-50:
Trustees or custodians, and employers, cannot place limits on the use of HSA assets. Employers and other potential account trustees and custodians wanted at least some limits on account administration.
The Notice strictly limits trustees' and custodians' duties. So, the trustees are not allowed to accept more than the annual HSA limit from an account holder (but they are not required to make further determinations on whether the specific account holder may exceed annual limits); restrict a party's right to roll over amounts; limit distributions to qualified medical expenses; and ignore the account beneficiary's age, (but they can rely on the individual's representation).
They are allowed to :refuse to accept rollovers; place reasonable limits on the frequency or amounts of distributions; and refuse to accept repayments of "mistaken distributions" from the HSA .
"There are three Q&A's that are barriers to direct employer restrictions on the use of HSA funds. Under Q&A-77, rollovers must be allowed (i.e., the agreement with the trustee/custodian holding the HSA must allow the employee to roll the money in the HSA to a new HSA trustee/custodian, which makes it difficult for the employer to keep the money with a trustee/custodian that the employer can control). Under Q&A-79, the trust or custodial agreement may not contain any provision that restricts the account beneficiary's right to anHSA distribution for any purpose (i.e., the employer will not be able to send its contributions to a trustee/custodian that has an HSA agreement restricting use of the employer's contributions to only approved health expenses). Under Q&A-82, an employer may not recoup from the HSA any portion of its contribution (i.e., the employer could not require that employer contributions be repaid by the employee in the event the employee tries to use them for a non-health expense). "Wincek- Legal Alert- Notice 2004-50: A Summer Tsunami of HSA Guidance (But WillEmployers Be Interested?), July 27, 2004
Other Employer Issues
The last part of the Notice 2004-50 ( Q&A- 81-87)addresses other employer issues:
- Employer's responsibility for the employee's eligibility is limited to that employer's HDHP and, in cases of catch-up contributions, the employee's age.
- An employer may not recoup any portion of the employer's contribution from an employee's HSA .
- Employer contributions to HSA s do not affect earned income credit calculations.
- For noncalendar year plans, the minimum annual deductible amounts and the maximum annual out-of-pocket expense limits may be based on the limits in effect on January 1st of the year in which the plan year falls.
- Residents of the U.S. Virgin Islands, Guam, and the Northern Mariana Islands may establish HSA s; residents of Puerto Rico and American Samoa may establish HSA s only after their jurisdictions enact statutes similar to IRC sec. 233" Washington Bulletin, Deloitte. July 26,2004
Summary- We are still very excited about HSA s. We feel employers should offer HSA s to employees who work for them. Understanding the current Guidance and what is allowed are crucial to having a successful HSA .
Rob J. Thurston, President of the Human Resources Consulting Group, has been a national speaker and noted author on HR consulting and systems development since 1981. He has implemented and designed some of the largest selling employee benefits software systems nationwide while part of a international brokerage firm, a national administration and as a consultant.He has available at no cost or obligation a comprehensive listing of HSA ,HRA , Debit/Credit Cards, software, and consulting firms providing advanced technology systems for benefits enrollment, communication and administration. Please request this list by calling Mr Thurston at
(801) 765-4417 ,
website www.hrconsultinggroup.com ;
1202 E. Dover Dr.
Provo, UT 84604.Anamaria Szekely, Organizational Development Consultant for Human Resources Consulting Group, has worked in several international locations (Europe) and in the United States as a human resources consultant. She graduated from the Babes— Bolyai University, Romania, her major being Organizational Behavior (‘Psychology,). She designed and implemented various projects on areas lik e organizational diagnosis, job security and performance evaluation.