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Guest Article

Deloitte logo

(From the July 26, 2004 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Latest-- and for a Time Last-- Round of HSA Guidance


Many open questions on Health Savings Accounts are resolved in the latest-- and most detailed-- guidance from Treasury and the IRS in Notice 2004-50, released July 23, 2004. The guidance covers issues on individual eligibility for HSAs, provides examples of plans that will be considered high-deductible plans, clarifies the scope of "preventive care," provides guidance on calculating permissible contributions and distributions, addresses the "comparability" nondiscrimination standard, rollovers, coordination between cafeteria plans and HSAs, and discusses various HSA administration issues. HSAs are established under IRC sec. 223. HSAs are available only to those covered by a high-deductible health plan (HDHP) or their dependents. These HSAs and HDHPs are integral parts of the "consumer-driven health" concept.

The Notice covers eleven categories of questions, summarized below.

Eligible Individuals

Employers can fund HSAs for their employees only if the employees are eligible individuals, and only employees who are eligible individuals can contribute to HSAs. In order to be an eligible individual, the employee must be covered by a high-deductible health plan and no other health plan, subject to specific exceptions. Many employers offer employees a choice of several health plans, including HDHPs and non-HDHPs. The guidance begins with the basic question: Can an employee that is permitted to choose between an HDHP and a non-HDHP still be an eligible individual if he or she chooses the HDHP? Yes, according to the Notice, because the actual health coverage selected-- as opposed to the options made available-- is what matters for purposes of determining whether an employee is an eligible individual. (Q/A 1)

Notice 2004-50 clarifies that an employee will not fail to be an eligible individual solely because he or she is covered by an EAP, disease management program, or wellness program, "if the program does not provide significant health benefits in the nature of medical care or treatment, and therefore, is not considered a 'health plan'." (Q/A 10) The Notice also explains that any screening or other preventive care services provided by these programs are disregarded for purposes of determining whether they provide "significant health benefits in the nature of medical care or treatment." This makes sense because coverage for preventive care is one of the primary exceptions to the HDHP requirement.

The Notice does not attempt to define a bright-line test employers can use to determine whether an EAP, disease management program, or wellness program provides significant health benefits in the nature of medical care or treatment. However, it does provide three examples of programs that are not "health plans," and consequently would not affect the individual's right to establish an HSA.

  • The EAP in Example 1 provides benefits consisting primarily of free or low-cost confidential short-term counseling to identify an employee's problem that may affect job performance and, when appropriate, referrals to an outside organization, facility, or program to assist the employee in resolving the problem. The issues addressed during the short-term counseling include, but are not limited to, substance abuse, alcoholism, mental health or emotional disorders, financial or legal difficulties, and dependent care needs.

  • The disease management program in Example 2, which identifies employees and their family members who have or are at risk for certain chronic conditions, provides evidencebased information, disease specific support, case monitoring, and coordination of the care and treatment provided by a health plan. Some typical interventions include monitoring laboratory or other test results, telephone contacts, or Web-based reminders of health care schedules, and providing information to minimize health risks.

  • The wellness program in Example 3, which is available to all employees regardless of whether they are enrolled in a health plan, provides a wide range of education and fitness services designed to improve employees' overall health and prevent illness. Typical services include education, fitness, sports, and recreational activities, stress management, and health screenings.

Another employer-provided benefit that has been the subject of questions is discount cards for prescription drugs and health care services. The Notice clarifies that employers can provide these discount cards to their employees without jeopardizing their status as eligible individuals "if the individual is required to pay the costs of the health care (taking into account the discount) until the deductible of the HDHP is satisfied." (Q/A 9)

Employees often first become eligible to participate in their employers' health plans on the first day of a pay period, which sometimes falls in the middle of a month. However, according to Notice 2004-50, an employee must be covered by an HDHP as of the first day of a month in order to be an eligible individual for that month. (Q/A 11) An employee that first becomes covered by his or her employer's HDHP on August 15 does not become an eligible individual, and thus is not eligible to establish or fund an HSA, until September 1.

Also of interest is the Notice's guidance on the "permitted insurance" exception to the HDHP rule. The statute generally defines permitted insurance as insurance relating to liabilities incurred under workers' compensation laws, tort liabilities, or liabilities relating to ownership or use of property. Permitted insurance also includes insurance for a specified disease or illness and insurance paying a fixed amount per day (or other period) of hospitalization. According to the Notice, permitted insurance generally must be provided through insurance contracts and not on a self-insured basis. However, workers' compensation benefits and other benefits mandated by statute generally will qualify as "permitted insurance" even if self-insured. (Q/A 8)

The Notice also explains that eligible individuals can be covered by an HDHP and by permitted insurance for one or more specific diseases, including cancer, diabetes, asthma, or congestive heart failure, "as long as the principal health coverage is provided by the HDHP." (Q/A 7)

Notice 2004-50 also provides the following additional guidance on eligible individuals.

  • An otherwise eligible individual who is eligible for Medicare benefits, but who has not yet enrolled in Medicare Part A or B, can continue to fund an HSA and make additional catch-up contributions if at least age 55. Once an individual enrolls in Medicare Part A or B, he or she no longer is an eligible individual. (Q/A 2, 3)

  • An otherwise eligible individual who is eligible to receive VA medical benefits, but who has not actually received such benefits during the preceding three months, can fund an HSA. (Q/A 5)

  • An individual receiving health benefits under TRICARE (the health care program for active duty and retired members of the uniformed services, their families and survivors) is not an eligible individual because the coverage options under TRICARE do not meet the minimum annual deductible requirements for HDHPs. (Q/A 6)

High-Deductible Health Plans

The Notice provides extensive guidance on certain specific issues relating to the HDHP definition. Of particular interest to employers, this section clarifies that an employer switching from a non-HDHP to an HDHP in the middle of the year can provide a credit against the HDHP deductible for unreimbursed expenses employees incurred during the previous health plan's short plan year. (Q/A 22) This may be an important consideration for employers that otherwise might not want to switch their employees to an HDHP in the middle of the year.

Also significant for employers is the statutory limit on out-of-pocket expenses for HDHPs. In general, a health plan does not qualify as an HDHP unless it limits annual out-of-pocket expenses for covered benefits to $5,000 for self-only coverage and $10,000 for family coverage. (These are the limits for 2004 only; the limits will be adjusted annually for inflation.) The Notice defines "family coverage" as any coverage other than self-only coverage. (Q/A 12)

The statute specifies that employee-paid premiums do not count against the annual out-of-pocket maximum. Amounts individuals pay to satisfy the deductible and any coinsurance or copayment requirements generally do count against the maximum, including copayments that are not taken into account for purposes of the deductible requirement. However, amounts incurred for benefits not covered by the HDHP do not count against the out-of-pocket maximum. (Q/A 21)

Penalties for failing to obtain pre-certification for a specific provider or service-- whether in the form of flat-dollar amounts or increased coinsurance or copayment requirements-- do not count against the out-of-pocket maximums. (Q/A 18, 19)

Many health plans impose a lifetime limit on all benefits, as well as annual or lifetime limits on specific benefits. The Notice clarifies that HDHPs may impose reasonable lifetime limits on all benefits, as well as reasonable annual or lifetime limits on specific benefits, and that amounts paid by covered individuals above these lifetime limits will not count against the annual out-ofpocket maximum. (Q/A 14, 15) According to an example in the Notice, a lifetime limit of $1 million is reasonable. Annual or lifetime limits on specific benefits are reasonable "only if significant other benefits remain available under the plan in addition to the benefits subject to the restriction or exclusion."

Plans may limit benefits to usual, customary, and reasonable (UCR) amounts. These are reasonable restrictions on benefits, and thus amounts covered individuals pay in excess of UCR that are not paid by the HDHP do not count against the out-of-pocket maximum. (Q/A 16)

As a general matter, an HDHP must limit out-of-pocket expenses either by design or by its express terms. The HDHP need not state an express limit if it is not necessary to prevent participants from exceeding the out-of-pocket maximum. (Q/A 17) For example, an HDHP with a $2,000 deductible for self-only coverage that pays 100 percent of covered expenses above the deductible does not need an express limit on out-of-pocket expenses.

The Notice also explains the rules for calculating the minimum deductible for an HDHP when the period for satisfying the deductible is longer than 12 months (Q/A 24), and clarifies that HDHP participants can take advantage of any plan-negotiated discounts from providers even if they have not yet satisfied the deductible (Q/A 25).

Preventive Care

Even though previous IRS guidance (Notice 2004-23) indicated preventive care generally cannot include any service or benefit intended to treat an existing illness, injury, or condition, Notice 2004-50 carves out an exception for "situations where it would be unreasonable or impracticable to perform another procedure to treat the condition." Thus, according to the Notice, "any treatment that is incidental or ancillary to a preventive care service or screening" qualifies as preventive care. The example cited is the removal of polyps during a diagnostic colonoscopy. (Q/A 26)

Notice 2004-50 also addresses the extent to which drugs or medications are preventive care. According to the Notice, "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 reoccurrence of a disease from which a person has recovered." (Q/A 27) Examples of when drugs or medications constitute preventive care include--

  • treating high cholesterol with cholesterol lowering medications (e.g., statins) to prevent heart disease, and

  • treating recovered heart attack or stroke victims with Angiotensin-converting Enzyme (ACE) inhibitors to prevent a reoccurrence.

The Notice also states that drugs or medications used as part of procedures providing preventive care services, including weight-loss and tobacco cessation programs, are preventive care.

Contributions

This section clarifies that anyone (including employers) can make contributions to an HSA on behalf of an eligible individual (Q/A 28), and also provides guidance on calculating an eligible individual's annual contribution limit in various circumstances. Specific situations addressed include--

  • eligible individuals with family coverage under an HDHP with embedded individual deductibles and an umbrella deductible (Q/A 30);

  • family HDHP coverage that includes an ineligible individual (Q/A 31); and

  • eligible individuals covered by an HDHP and also by a post-deductible HRA (Q/A 33).

Spouses may divide HSAs any way they wish. However, if they do not stipulate a specific division of the HSA, the HSA will be deemed to be equally divided between the spouses. (Q/A 32). An HSA holder can withdraw excess contributions to the HSA before year end and avoid the 6 percent excise tax on the excess, but the holder also must calculate and distribute earnings on the excess, using the rules for calculating income on excess IRA contributions. (Q/A 34). HSA holders withdrawing amounts for nonmedical expenses will be subject to income tax on those amounts and, unless the withdrawal is due to death, disability, or Medicare eligibility, a 10 percent withdrawal penalty. (Q/A 35).

Payments and Distributions from HSAs

Distribution clarifications generally are generous. The HSA holder may pay for spouses' or dependents' medical expenses, regardless of whether the spouses or dependents are covered by HDHPs, but such expenses cannot be reimbursed more than once. (Q/A 36, 38) Mistaken distributions (such as an expense thought to be a qualified medical expense) can be repaid to the HSA if made by April 15 of the next year, although HSA trustees are not required to accept these repayments. (Q/A 76) There is no time limit on how long an HSA holder can wait to have medical expenses repaid from the account; however, the IRS emphasizes the need to retain records to confirm expense eligibility. (Q/A 39)

In a boost for paying for long-term care (LTC) insurance with pretax employee money, the IRS permits HSAs funded under a IRC sec. 125 cafeteria plan to pay for LTC premiums. In the IRS's view, the IRC sec. 125(f) bar on offering LTC insurance as a cafeteria plan benefit does not apply because the LTC insurance is being provided by the HSA and not the IRC Sec. 125 cafeteria plan. HSAs may pay for long-term care premiums, but only up to the age-based annual limits under IRC sec. 213. HSAs also may pay for LTC services, whether the HSA is funded through a cafeteria plan or otherwise. (Q/A 40-42)

Individuals age 65 or older and eligible and enrolled in Medicare may use the HSA to pay for Medicare premiums (including reimbursing the payee for premiums withheld from Social Security payments) and the retiree's share of employer-provided health care costs. Individuals under age 65 and covered by Medicare for end-stage renal disease or disabled cannot use the HSA to pay for Medicare or other medical premiums. (Q/A 43-45)

"Comparability" and Nondiscrimination

Employer-provided HSA contributions are subject to fairly lax nondiscrimination requirements in the form of a "comparability" rule that requires the employer to make "comparable" contributions for all eligible employees (i.e. those in a high-deductible plan). The guidance notes that according to the legislative history, this comparability rule does not apply to HSA contributions made through a cafeteria plan.

However, the rules for employer-paid HSA contributions seem rather strict. An employer match of the employee's contribution does not necessarily satisfy the comparability rule, nor would an age-based contribution or contributions based on participation in a wellness, disease management, or similar program. If the employer contributes to an HSA for any employee enrolled in the employer's HDHP, the employer must contribute a comparable amount for all employers in the employers HDHP. Likewise, if the employer contributes to an HSA for an employee enrolled in any HDHP, the employer must contribute to the HSAs of all such employees. Contributions can be based on a month to month basis, thus employees working less than 12 months can be treated differently than those working the entire year. After tax employee contributions are not subject to the comparability rules. (Q/A 46-54)

Rollovers Among HSAs

The rollover rules for HSA balances closely follow the IRA rollover rules. Only one rollover per year is permitted if the account holder receives the HSA amount and rolls it to a new HSA; however, trustee to trustee rollovers are unlimited. (Q/A 55-56)

Cafeteria Plans and HSAs

Unlike FSAs under a cafeteria plan, HSAs are not subject to the use-it-or-lose rule, the maximum annual account availability at all times rule, or the mandatory 12-month period of coverage. Because both the eligibility and the contribution requirements for HSAs are determined on a month by month basis, the mid-year election change rules that apply to sec. 125 cafeteria plans do not apply to HSAs offered under cafeteria plans. However, the fact HSA changes are permitted does not affect other cafeteria plan change in status rules. Consequently, those other coverages could prevent the employee from qualifying as an "eligible individual" for HSA coverage. Employers can fund an HSA that is part of a cafeteria plan in advance, but the employer will not be able to recover that amount from the employee if the employee leaves the company. Employers can provide "negative elections" for HSAs offered under a cafeteria plan. (Q/A 57-61 and Q/A 82)

Account Administration

The Notice refers to the model forms available for establishing HSAs and reiterates that the accounts can be invested in any investment available to IRAs. Spouses cannot have joint HSAs, but individuals can have as many HSAs as they wish, although the annual permissible cumulative amount cannot be exceeded. HSAs can be held in a common trust or investment fund. Prohibited transaction rules similar to those applying to IRAs (no loans or encumbrances on the account, etc.) apply to HSA beneficiaries, trustees, and custodians. Administrative fees can be paid from the account, without incurring taxable income to the beneficiary, but the annual account contribution limits cannot be increased to recognize the fee. However, administrative fees paid directly by an employer or the account beneficiary do not count against the annual contribution limit. (Q/A 62-71)

Duties and Limits on Trustees and Custodians

The responsibilities of trustees and custodians had been the major road block to release of this Notice. Reports indicate the White House was adamant that trustees or custodians, especially those who were employers, could not place limits on the use of HSA assets. Employers and other potential account trustees and custodians wanted at least some limits on account administration. The Notice strictly limits trustees' and custodians' duties. Among the trustees' or custodians' few duties and responsibilities, they must not:

  • Accept more than the annual HSA limit from an account holder (but they are not required to make further determinations on whether the specific account holder may exceed annual limits);

  • Restrict a party's right to roll over amounts;

  • Limit distributions to qualified medical expenses; and

  • Ignore the account beneficiary's age, (but they can rely on the individual's representation).

But they may:

  • Refuse to accept rollovers;

  • Place reasonable limits on the frequency or amounts of distributions; and

  • Refuse to accept repayments of "mistaken distributions" from the HSA.

(Q/A 72-80)

Other Employer Issues

With respect to other employer issues:

  • An employer is responsible for determining an employee's eligibility and contribution level for HSAs only with respect to that employer's HDHP and, in cases of catch-up contributions, the employee's age.

  • An employer may not recoup any portion of the employer's contribution from an employee's HSA.

  • Internal Revenue Code Sec. 105(h) nondiscrimination rules do not apply to HSA distributions.

  • Employer contributions to HSAs do not affect earned income credit calculations.

  • For noncalendar year plans, the minimum annual deductible amounts and the maximum annual out-of-pocket expense limits may be based on the limits in effect on January 1st of the year in which the plan year falls.

  • Residents of the U.S. Virgin Islands, Guam, and the Northern Mariana Islands may establish HSAs; residents of Puerto Rico and American Samoa may establish HSAs only after their jurisdictions enact statutes similar to IRC sec. 223.

(Q/A 81-83, 85-87)


Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Tom Brisendine 202.879.5365, Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Mike Haberman 202.879.4963, Stephen LaGarde 202.879.5608, J. D. Lutz 202.879.5366, Bart Massey 202.220.2104, Diane McGowan 202.220.2077, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5324, Tom Veal 312.946.2595, or Deborah Walker 202.879.4955.

Copyright 2004, Deloitte.


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