IRS Issues Final Rules for HSAs

? We are devoting this issue solely to the new regulations released by the IRS - Notice 2004-50

As I predicted when the law was first passed, 2004 is a year of getting organized. The product development process is nearly complete for most vendors, partnerships with financial institutions are being finalized, marketing plans are rolling out, and now the IRS has finished issuing regulations. Everything is in place for a massive marketing effort this Fall and major enrollment gains effective 1/1/05.

While the Service is to be commended for the speed with which it has developed the HSA rulings, it is getting a tad confusing because of the several different sets of guidance that are now in effect. Readers who have an interest in HSAs are encouraged to print out all the rulings and put them in a binder for future reference. I also encourage the Service to compile all its ruling into a single set of papers with an index so people will be able to locate the answers to their questions.

This new ruling (Notice 2004-50) settles a number of outstanding issues. I will discuss some of them below in rough order of importance - at least to me. WARNING!! What follows will likely be tedious and boring if you are not an insurance junky.

SOURCE: http://www.treasury.gov/press/releases/reports/hsanotice200450072304.pdf

Family Deductible

Probably the biggest news of the new regulations is the guidance on how family deductibles affect HSA contributions. From earlier rulings, it appeared that family HSA contributions would be the lower of a full family (whole or umbrella) deductible, or an individual (stacked or embedded) deductible. So if a three-person family had a $3,000 deductible that started paying benefits when one member of the family incurred $1,000 in expenses, the maximum HSA contribution would be $1,000. Now, questions 30 and 31 revise that understanding completely. The answer to Question-30 says (in part),

"The maximum annual HSA contribution limit for an eligible individual who has family coverage under an HDHP with embedded individual deductibles and an umbrella deductible as described above is the least of the following amounts:

1. The maximum annual contribution limit for family coverage specified in section 223(b)(2)(B)(ii) ($5,150 for calendar year 2004);

2. The umbrella deductible; or

0. The embedded deductible multiplied by the number of family members covered by the plan."

So, in the example above, the allowable contribution would not be $1,000, but $3,000. This is very good news in a market that is characterized by embedded deductibles.

Q&A-31 goes even further. It allows 100% of a family deductible to be contributed, even if only one member of the family is eligible for an HSA. The example it provides is:

"H and W have family HDHP coverage with a $5,000 deductible. H is an eligible individual and has no other coverage. W also has self-only coverage with a $200 deductible. W, who has coverage under a low-deductible plan, is not an eligible individual. H may contribute $5,000 to an HSA while W may not contribute to an HSA." It provides another example in which H and W have a $5,000 deductible family policy and W also has a $2,000 self-only deductible, and so is an eligible individual. H and W may both contribute toward the $5,000 maximum HSA contribution.

Spousal Issues

While we're on the issue of family coverage and HSAs, Q-63 clarifies something I didn't realize before - spouses may not have joint HSAs. It says, "Each spouse who is an 'eligible individual' ? and wants to make contributions to an HSA must open a separate HSA." But one spouse may use his or her HSA to pay for the qualified medical expenses of the other spouse (Q-38).

Even more interesting, Q-36 says that an account holder may withdraw money from an HSA to pay the medical expenses of a family member who is not on a qualified high-deductible health plan. So, if George has an HSA and Jane is covered by a Kaiser HMO, George can withdraw money to pay for Jane's medical expenses - all on a tax-free basis.

Preventive Care

The new rules provide even more flexibility in coverage of preventive services. Q-26 allows first-dollar coverage of treatment services that are "incidental or ancillary to a preventive care service or screening." It provides as an example, the removal of polyps during a diagnostic colonoscopy. Q-27 allows coverage of drugs that are used to prevent disease, such as statins or ACE inhibitors. Specifically it says that "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 reoccurance of a disease from which a person has recovered." Remember, the Service is not requiring that these things be covered, only saying that they do not have to be subject to the deductible of the HDHP.

Risk Pools

Q&As 13 and 29 clarify that a risk pool may be set up as an HDHP, and that state government may contribute to the HSA of an enrollee in a risk pool. In fact, Q&A 28 clarifies that anyone may contribute to a person's HSA - so church groups, charitable organizations, labor unions, and philanthropists could help a low-income person fund an HSA.

Long Term Care

There is a lot of information on LTC in the new guidance. Q-49 clarifies that, even though LTC premiums may not be paid directly through a section 125 cafeteria plan, if the HSA is funded through a cafeteria plan, LTC premiums may be paid for through the HSA. However, Q-41 requires that the section 213(d)(10) age limitations on tax deductible LTC premiums still apply, even if those premiums are paid through an HSA. As an example, it cites someone who is age 41 and pays a premium of $1,290 for a qualified LTC policy from an HSA. The age limitations allow only $490 in LTC premiums to be tax deductible for people in their forties. So $800 dollars of that premium payment would be considered an unqualified medical expense and subject to taxes and the 10% penalty.

Q-42 clarifies that, even though LTC services (not premiums) paid through a flexible spending account or otherwise paid by an employer are included in the employee's gross income (i.e., not tax advantaged), they are qualified medical expenses when paid through an HSA. It doesn't matter if the HSA is funded by an employer or through a cafeteria plan.

Comparability Rules

There are a lot of Q&As addressing the issue of comparable contributions by an employer, and the Service interprets it fairly strictly. Q-46 says employers will violate the comparability rules if they simply match whatever HSA contribution the employee makes, because that would result in different employees receiving different contributions. However, Q-47 says that comparability rules do not apply to cafeteria plan funding, so an employer may use a matching formula if the HSA contributions are made through a section 125 cafeteria plan. The same applies to varying contributions based on participation in health assessments and wellness programs - the employer's contribution may not vary based on those criteria unless it is made through a cafeteria plan (Q&As 48 & 49).

The guidance also says an employer may not vary an HSA contribution according to age or qualification for the catch-up provisions (Q-50). It does not mention a cafeteria plan exception to this rule.

Q-53 says that the comparability rules do not require an employer to make the same contribution to the HSA of an employee who is not covered by the employer's HDHP (i.e., who has a HDHP from another employer) as it does to people covered by the employer's plan.

Employer Controls over HSA Funds

Finally, these regulations were held up by a dispute over whether employers should continue to have any control over HSA funds the employer contributed. The Service came down solidly on the side of the HSA money being the sole ownership of the account holder in a number of questions.

Q-79 asks whether the HSA trust may restrict HSA distributions to qualified medical expenses only. The answer is "No." It says, "The account beneficiary is entitled to distributions for any purpose and distributions may be used to pay or reimburse qualified medical expenses or for other non-medical expenditures. Only the account beneficiary may determine how the HSA distributions may be used."

Q-82 asks whether employers may recoup any portion of the employer's HSA contribution, and the Service says "No." Once the money is in the account it is "nonforfeitable." So, an employer who fully funds a worker's HSA in January cannot recover the money if the worker quits in February.

There are plenty of other issues dealt with in the new guidance. Anyone with a vital interest in HSAs needs to acquire and read a copy of this Notice (and all the prior rulings, too). This is it, folks. These are what HSAs will be about for the foreseeable future.

Please send all comments/questions directly to me at gmscan@aol.com.

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