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HSA's are Alive and Well and Growing - December 2007

By John M. Wirtshafter, Esq. McDonald Hopkins LLC

The era of Health Savings Accounts, commonly referred to as HSAs, began almost four years ago when President Bush signed the Medicare bill. HSAs have had an explosion of growth since that time. The Department of Treasury estimates that from 2004, when 438,000 people were covered under an HSA, there has been a more than ten-fold increase; approximately 3.2 million covered individuals at the end of 2005 and close to 4.5 million enrollees by the end of 2006. The government estimates that more than 10 million individuals will be covered by HSAs by the end of this decade.

Preliminary feedback from participants in, and sponsors of, HSAs is somewhat mixed. However, sponsors and administrators that have taken the time to educate their enrollees on how their plans work and how to make good health care decisions have clearly resulted in higher satisfaction among enrollees and greater cost-savings.

Both Congress and President Bush have been eager to continue that growth. Consequently, Congress included taxpayer-friendly changes to HSAs in the Tax Relief and Health Care of Act of 2006 (the ?06 Act), and the President signed those changes into law on December 20, 2006.

An HSA is an investment account to which contributions are made. The contributions must be used for qualified medical expenses by the HSA?s beneficiary. Once an individual reaches age 65 or Medicare eligibility, contributions can be withdrawn for any reason.

There are various requirements and limitations placed on how HSAs function and who can use them.

Contributions to an HSA can only be made by, or on behalf of, an individual covered by what is called a ?high deductible health plan,? or HDHP. An HDHP is simply a medical plan that has a ?high? annual deductible. To qualify as an HDHP under the HSA rules, the deductible cannot be less than a certain amount, which this year is $1,100 for individuals and $2,200 for families. The amounts are indexed for inflation and change periodically. HSA contributions must be held in a trust and the trustee must be a bank, insurance company or approved non-bank custodian.

If an employer makes contributions to an HSA for any employee, the employer is required to make comparable HSA contributions for all comparable participating employees. Comparable participating employees are eligible individuals who are in the same category of employees and who have the same category of high deductible health plan (HDHP) coverage. Employees covered by a collective bargaining agreement in which health benefits were part of the agreement are not covered by the comparability rules. Contributions are comparable if they are either the same amount or the same percentage of the deductible under the HDHP for employees who are eligible individuals with the same category of coverage.

The comparability requirements do not apply where employers make contributions through a cafeteria plan. Instead, such contributions are subject to the Section 125 nondiscrimination rules. When making contributions under a Section 125 Plan, employers may condition contributions to an employee's HSA on the employee's participation in a health assessment, disease management or wellness program. Under an HSA that is operated outside of a Section 125 plan, conditioning employer contributions on participation in such programs is prohibited.

The HSA contributions can be used for qualified medical expenses until the HDHP?s deductible is reached. Expenses may include COBRA premiums, premiums while unemployed, long-term care premiums and retiree medical premiums (other than a Medicare supplemental policy). Once the deductible is reached, the HDHP begins paying the medical expenses. Any remaining money in the HSA is carried forward into future years until used.

HSAs create two savings incentives. First, the contributions are deductible from the contributor?s income, normally a benefit for employees because they typically make the contributions. Second, because the deductibles are high in the HDHP, health plan premiums should be less, a benefit to employers who pay the premiums for employee health coverage.

While there is a minimum deductible for an HDHP, there is similarly a cap on how much can be contributed to an HSA. The limit for contributions is applied annually. Prior to the ?06 Act, the contribution limit depended on the HDHP deductible amount, which can vary depending on the type of plan being used. This cap has been eliminated and beginning this year, individuals can contribute a pre-set statutory amount. The amounts this year are $2,850 for individuals and $5,650 for families and, because each is indexed to inflation, will increase periodically.

The ?06 Act also includes other provisions that seek to make a transition into HSAs more desirable.

Individuals are now permitted to make a one-time, limited transfer from their health-flexible spending accounts (FSAs). The transfer must take place after December 20, 2006 but before January 1, 2012. Though an FSA is similar to an HSA, it does not require the HDHP, the backbone of HSAs.

FSA contributions also do not rollover into the next year so funds in an FSA must be used for the year contributed or they are lost. FSA funds are used to pay for qualified medical expenses. Thus, if out-of-pocket medical expenses incurred in a year are not at least equal to what has been contributed to the FSA, the balance in the FSA is forfeited.

The FSA to HSA transfer does not count against the annual contribution limit for an HSA. Thus, for the year in which the FSA transfer is made, a taxpayer can contribute beyond the statutory limit into his or her HSA. While there are certain limits and restrictions in place, the ability to transfer from an FSA to an HSA can be beneficial for employees who have significant balances in their FSAs at the end of the year and who would otherwise forfeit unused dollars because they did not incur sufficient medical expenses during the year.

Similarly, taxpayers can make a one-time, tax-free transfer from an IRA into an HSA, though the transfer cannot be made before 2008. Unlike the FSA rollover, this does count against the HSA annual contribution limit.

The ?06 Act permits full year contributions for partial year participants. Previously, new enrollees in an HDHP could only contribute to their HSA for the full months enrolled in the HDHP. This limitation has been removed and an enrollee may now contribute the entire year?s contribution regardless of the number of months enrolled.

With these changes, we expect that the enrollments in HSA plans should continue to grow, especially if employers provide the appropriate education concerning HSA benefits.

(John M. Wirtshafter is a Member of McDonald Hopkins LLC and focuses his practice on employee benefits and executive compensation issues. McDonald Hopkins LLC is headquartered in Cleveland, Ohio with offices in Columbus, Detroit, Chicago and West Palm Beach. If you think that an Health Savings Account may be appropriate for your business or you would like to consult with the author, Mr. Wirtshafter can be reached at: jwirtshafter@mcdonaldhopkins.com or (216) 348-5833.)

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