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HSAs Suddenly More Attractive for 2007 Due to Last-Minute Tax Bill
By Jeff Belfiglio
[December 2006]
Right in the middle of open enrollment season, Congress has enhanced Health Savings Accounts (HSAs). These changes, effective in 2007, allow HSA participants to build up an HSA balance even faster, and give employers some greater flexibility too. An employer currently offering an HSA option will want to publicize these changes to employees. They were tacked onto the final tax bill passed by the lame-duck Congress. (The pending changes were previewed at our November client seminar, but passage then was uncertain.)
Increased Contributions
The new rules allow annual HSA contributions up to the full statutory limit ($2,850 for single coverage, $5,650 for family coverage in 2007), regardless of the plan deductible. Previously, the limit was the lesser of the deductible or the dollar limit. This allows HSA participants to contribute enough to cover their deductible and some of their out-of-pocket maximum. It also greatly enhances the tax-shelter value of an HSA for those who contribute to it without needing to draw on the account for medical expenses.
Full-Year Contributions
Previously, it was difficult to implement or join an HSA mid-year, because the contribution limit was pro-rated on a monthly basis, so the participant could not contribute enough to cover the full year’s deductible. Now a participant enrolling in an HSA plan any time in the year, continuing through the last month of the year, and covered only by a high-deductible policy at that time, can contribute the full year’s dollar limit. There is a tax penalty if the participant does not remain in the HSA for at least a year, however.
“Rollovers” From HRAs, FSAs, and IRAs
To further help participants build their HSA balances, the law allows one-time tax-free transfers of unused balances in an FSA or HRA to an HSA. Employers will have to consider whether they want to allow such transfers from these plans, because FSAs and HRAs are usually unfunded bookkeeping accounts, while the transfer will require an employer to send cash to the employee’s own HSA, where it might not be used as originally intended. Also, an employer must allow the transfer to all participants if it is allowed for anyone. The amount that can be transferred is limited to the lesser of the balance on Sept. 21, 2006 or the balance on the date of the transfer, which must occur during 2007-2011. Further clarification of this limit is expected.
The law also allows a one-time tax-free transfer from an individual IRA (not a SEP or SIMPLE IRA) to an HSA. The transfer is limited to the maximum contribution limit for the HSA in the year of transfer. Such a transfer counts against the contribution limit for the year, so this is really an alternative means of funding a year’s contribution to an HSA. There is also a penalty if the individual ceases to be eligible for the HSA within 12 months.
Technical Fix to “Grace Period” Problem
Currently, a participant in an FSA that has the 2-½ month “grace period” is treated as having disqualifying coverage during the grace period and cannot contribute to an HSA for those months. The new law removes this restriction if the FSA balance was zero at the end of the FSA plan year, or the FSA balance is transferred to the HSA as described above. This does not fully fix the grace period problem, but note that the ability to contribute the full year’s limit even if covered by an HSA for only part of the year (see above) makes this problem less severe.
Comparable Employer Contributions
The new law allows an employer to ignore highly compensated employees when determining whether it is making “comparable” contributions (the same dollar amount or percentage of the deductible) for non-HCEs. In other words, this allows bottom-heavy employer contributions. However, the employer can gain much more flexibility to design its HSA contributions by making them “through a cafeteria plan.” The final comparability rules make it clear that simply by allowing employees to contribute to HSAs on a pre-tax basis through a cafeteria plan, any employer contributions are exempt from the comparability rules (but subject to cafeteria plan rules instead). This allows a greater variety of employer contribution designs, such as matching contributions or contributions geared to participation in a wellness program.
These are significant sweeteners to an HSA plan – certainly more than could be expected from the new Congress. As the changes are publicized, more employees may be interested in switching to an HSA.
For further information, please contact:
Davis Wright Tremaine has employment and labor lawyers in Alaska, Oregon, Washington state, California and Washington, D.C. We represent many clients nationally. For a specific referral for a DWT employment and labor attorney in your state, please contact the above attorneys. Thank you.
This Advisory is a publication of the Employer Services Department of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of recent developments in employment law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may be given only in response to inquiries regarding particular situations.
Copyright © 2006, Davis Wright Tremaine LLP.
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