December 11, 2006
Congress Revamps Rules for Health Savings Accounts; Law Expected to be Signed by President Soon
On Saturday, December 9, 2006, Congress passed the Tax Relief and Health Care Act of 2006 (“Act”). This Act includes many new provisions applicable to Health Savings Accounts (“HSAs”), and is expected to be signed into law by President Bush soon. The new law is designed to increase the use of HSAs and to increase the transition into high-deductible health plans. We expect further guidance from the IRS regarding the applicability of these rules in the near future. The following is a brief summary of some of the major changes.
- One time rollover from a Health Flexible Spending Account (“Health FSA”) or Health Reimbursement Arrangement (“HRA”) into an HSA. Currently, no amount can be rolled over from a Health FSA or HRA into an HSA. Under the new law, certain amounts in a Health FSA or HRA can be contributed through a direct transfer to an HSA via a “qualified HSA distribution.” The distribution would not violate the otherwise applicable requirements for such arrangements. However, in most cases, the employee must remain eligible for HSA contributions for the 12-month period following the contribution, or the contribution will be included in the employee’s income and an additional 10% tax will be imposed. The amount that can be distributed from the Health FSA or HRA may not exceed an amount equal to the lesser of: (1) the balance in the Health FSA or HRA as of September 21, 2006, or (2) the balance in the Health FSA or HRA as of the date of the distribution. The provision is limited to one distribution with respect to each Health FSA or HRA of the individual. The rollover must be done after the date of the enactment of the Act and before January 1, 2012. Plan documents will need to be revised to allow for this new rollover provision.
- Certain Health FSA Coverage Disregarded. Under current law, if an employer amends its cafeteria plan to provide a grace period, participants under the cafeteria plan are not eligible to contribute to an HSA during the grace period, even if a participant spent the entire Health FSA balance by the end of the plan year and did not take advantage of the grace period. Beginning after December 31, 2006, if an employer has amended its cafeteria plan to provide a grace period, the grace period will be disregarded for determining a participant’s eligibility to contribute to an HSA if: (1) the balance in the participant’s Health FSA account at the end of the plan year is zero, or (2) in accordance with rules prescribed by the IRS, the entire remaining balance in the participant’s Health FSA account at the end of the plan year is rolled over into an HSA. We anticipate further IRS guidance regarding this issue soon.
- HSA Annual Plan Deductible Limitation is Repealed. Under existing law, the maximum monthly contribution for eligible individuals with individual coverage under a High Deductible Health Plan (“HDHP”) is the lesser of 100% of the annual deductible under the HDHP or a limit that is indexed for inflation. For 2007, the applicable limit for individual coverage is $2,850 and $5,650 for family coverage. Beginning after December 31, 2006, the Act repeals the limit applicable to HSA contributions with respect to the annual deductible under the HDHP. These changes effectively make the aggregate annual contribution that an individual can make to an HSA the same for all individual’s with individual coverage ($2,850 for 2007) and the same for all individual’s with family coverage ($5,650 for 2007). The individual’s deductible will no longer be considered in determining the applicable contribution limit.
- Earlier Indexing of Cost of Living Adjustments. Under current law, any cost of living adjustments for HSA contributions and HDHP requirements are made based on the Consumer Price Index as of the close of the 12 month period ending on August 31. For tax years beginning after 2007, the Act requires that any cost-of-living adjustments for HSA contributions and the HDHP requirement for a calendar year be based on the Consumer Price Index changes as of the close of the 12 month period ending on March 31 of the calendar year. In addition, the Act also requires the IRS to publish the adjusted amounts no later than June 1 of each year.
- Full Contributions for any Participation during the Year. Under existing law, an individual has to participate in a HDHP for a full 12 months to be eligible to make a full HSA contribution. For any month that an individual does not participate in an HDHP, the annual HSA contribution limit is reduced by 1/12th. Beginning after December 31, 2006, the Act provides that an individual who becomes covered under an HDHP in a month other than January, may make a full deductible HSA contribution for the year if certain conditions are met.
- Employer Comparable Contributions Rules Modified. As we outlined here, if an employer makes contributions to an employee’s HSA, the employer must make available comparable contributions on behalf of all employees with comparable coverage during the same period. Beginning after December 31, 2006, employers may make larger HSA contributions for non-highly compensated employees than for highly compensated employees. The comparable contribution rules will continue to apply to the contributions made to non-highly compensated employees so that the employer must make available comparable contributions on behalf of all non-highly compensated employees with comparable coverage during the same period. This means an employer can make a contribution to just the non-highly compensated employees, but all the non-highly compensated employees must receive the same contribution based on the type of coverage.
- One-time Rollover from IRAs into HSAs. Under current law, amounts cannot be rolled over from an IRA into an HSA. Beginning after December 31, 2007, the Act allows an individual to make a one-time contribution to an HSA of an amount distributed from an IRA. The contribution must be made in a direct trustee-to-trustee transfer. Amounts distributed from the IRA are not includible in the individual’s income and are not subject to the 10-percent additional tax on early distributions. The amount that can be distributed from the IRA and contributed to an HSA is limited to the otherwise maximum deductible contribution to the HSA computed on the basis of the type of coverage under the HDHP at the time of the contribution. No deduction is allowed from the amount contributed from an IRA to an HSA. Only one rollover contribution is allowed. The changes do not apply to simplified employee pensions (“SEPs”) or to SIMPLE retirement plans. Additional restrictions on IRA rollovers may apply.
The foregoing is a brief summary of the various provisions of the Act. The Act contains additional details not addressed here. Please let us know if you have any questions regarding this new legislation or if you need assistance updating your plan documents to comply with the new changes.
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The information contained in this ALERT is intended for general information purposes only and does not constitute legal advice relative to a specific situation.