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Godfrey & Kahn Updates

Health Savings Account Changes

January 31, 2007

Although health savings accounts (HSAs) have received a significant amount of media attention since they were first introduced in 2004, their use by employers remains relatively low for a variety of reasons. Since 2004, the U.S. Treasury Department has issued several sets of rules to try to make HSAs more practical and user-friendly, but many problems persisted.

To alleviate some of these problems, President Bush signed the Tax Relief and Health Care Act of 2006 into law on December 20, 2006. The Act made the following important HSA changes:

  1. Contribution Increases. In order to make an HSA contribution, a taxpayer must be covered by a high deductible health plan. Previously, a taxpayer was subject to an annual HSA contribution limit of the lesser of (1) the annual deductible under the taxpayer's high deductible health plan, or (2) a statutory dollar limit. The Act eliminates the annual deductible limit. Consequently, many taxpayers may now contribute more to their HSAs. An employee who currently is making pre-tax HSA contributions through his or her employer's cafeteria plan can take advantage of the new limit by changing his or her cafeteria plan election at any time to increase the HSA contributions (assuming the plan permits the change).

  2. Earlier Cost of Living Adjustments. Beginning with the 2008 tax year, cost of living adjustments for annual HSA contribution limits will be published by June 1 of the preceding year. Currently, these adjustments are made toward the end of the calendar year. This change should ease employers' administrative problems that arose previously during open enrollment due to the late issuance of the next year's HSA limits.

  3. Comparable Contributions. Previously, an employer that contributed to its employees' HSAs outside of a cafeteria plan generally was required to make comparable contributions to the HSAs of comparable participating employees. Under the Act, an employer may make larger HSA contributions for non-highly compensated employees than for highly compensated employees.

  4. Flexible Savings Account and Health Reimbursement Arrangement Transfers. The Act permits an employee to make a one-time transfer from his or her health care flexible savings account (FSA) and/or health reimbursement arrangement (HRA) to a health savings account until January 1, 2012. The transfer must be permitted by the FSA or HRA and may not exceed the lesser of the balance in the FSA or HRA as of either September 21, 2006 or the date of the transfer. If an employee makes a transfer but does not remain eligible to contribute to an HSA for the following 12 months, the employee will be subject to income tax on the transfer and a 10% penalty (unless the ineligibility is due to the employee's death or disability). An FSA or HRA transfer does not count toward an employee's annual HSA contribution limit.

  5. Disregarded Flexible Spending Account Coverage. Previously, an employee who participated in an FSA that included a grace period after the end of the plan year was ineligible to contribute to an HSA during the grace period, even if the employee had no balance in the FSA as of the end of the plan year. Effective for tax years beginning after December 31, 2006, an employee will be eligible to contribute to an HSA during his or her FSA's grace period if (1) the employee has no account balance in the FSA as of the end of the plan year, or (2) the employee elects to transfer the FSA account balance as of the end of the plan year to the HSA (even if the rollover cannot be completed until a later date).

  6. Mid-Year Enrollees. Previously, an individual could make HSA contributions only for those months for which he or she was HSA-eligible. However, high deductible health plan deductibles are not prorated when an individual becomes covered mid-year. To address this problem, the Act now permits an individual who is HSA-eligible in the last month of a tax year to make HSA contributions for all previous months in that tax year. As a result, an individual can now make HSA contributions for months before he or she was enrolled in a high deductible health plan. However, if the individual does not remain HSA-eligible for all of following tax year for any reason other than his or her death or disability, then the excess HSA contributions are subject to income tax and a 10% penalty.

It appears that these changes, especially the contribution increases, will make HSAs more attractive to many
employees. Additionally, the easing of the comparable contribution requirements and the earlier cost of living adjustments may make HSAs a more viable health plan mechanism for employers.

If you have any questions, please contact Todd Cleary (414- 287-9433 or or any other member of Godfrey & Kahn's Employee Benefits Team.

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