Just before adjourning for the year, Congress approved a $1 billion expansion of HSAs that will make them even more attractive vehicles than before. Since this is the best place on the internet to get updates on tax policy, below is a comprehensive detailing of the bill language and provisions (in order of legislative language):
1. Rollovers will be allowed from flexible spending accounts (FSAs) and health reimbursement arrangements (HRAs). The former are "use it or lose it" pre-tax accounts to pay for out-of-pocket costs of traditional insurance (co-pays, eyeglasses, etc.) The latter are high-deductible health plans whose savings account component (the HRA) is held by the employer, not the individual.
Prior to this, these accounts often became "orphaned" when an employer switched to an HSA. Now, any unused funds from FSAs or HRAs can roll into HSAs.
The rollover must happen before 1/1/2012, and is one-time only for each account. The amount that can be rolled over is the lesser of the account value at rollover or the account value on 9/21/2006. Employers must make the option open to each employee who has these accounts.
2. FSA coverage during the "grace period" for use-it-or-lose-it (until March 31st of the subsequent year) will not disqualify someone from opening an HSA in that plan year provided that the FSA account is fully-distributed or rolled into an HSA by the end of the grace period.
3. The deductible limitation on HSA contributions is repealed. Under the old rules, the maximum that could be contributed to an HSA was the lesser of the deductible or the dollar limit. If you had an HSA with a deductible below the dollar limit, you could only put in the value of the deductible.
Starting in 2007, the dollar limit is the only upper limit on what can be contributed to an HSA. For 2007, the dollar limit will be $2850 for self-only coverage and $5650 for family coverage. This amount can be contributed to HSA-qualifying plans with deductibles as low as $1100 for self-only and $2200 for families. As a result, money can accumulate in HSAs much more quickly, and one need not fear having an early catastrophic year.
4. The cost of living increase will be announced as of March 31st of a year, rather than August 31st. This will allow plans and employers to update their literature and plan for the year much earlier.
5. A full year's HSA contribution will be allowed even if one enrolls in the middle of the year. Under the old rules, the HSA contribution limit was a monthly one. As an example, suppose the most you could contribute to your HSA was $2000 for the year, and you enroll in September. You would only be able to make 4/12ths of your normal contribution, or $500.
As of 2007, you will be able to contribute the full amount for the whole year, no matter when you enroll. Even better, the only upper limit is the dollar cap. This will further help new enrollees accumulate substantial assets in their HSAs.
A person must be an eligible individual during the last month of the year, and must remain in a high-deductible health plan for at least 12 months after the end of the calendar year in which he enrolls. Failure to do so results in the individual being defaulted into the old (current) rules, and he will have made an excess contribution to his HSA (triggering an excise tax penalty).
6. Employers will be able to contribute more to non-highly compensated employees than to highly-compensated employees. This will help lower-income employees have more confidence in HSAs as a safety net.
7. A one-time tax and penalty-free rollover from an IRA to an HSA will be allowed. It must be done as a trustee-to-trustee transfer.
The amount of the IRA rollover reduces the amount of HSA contributions that can be made. Thus, it is part of the overall calendar-year dollar limit on HSA contributions. This can only be done once in a taxpayer's lifetime, unless he later in the same year switches over to family coverage.
For 12 months after the last calendar year in which this rollover takes place, the individual must remain enrolled in an HSA-qualified health plan. Failure to do so recharacterizes the IRA rollover as an early distribution, with its resultant taxes and penalties.
This has several implications for HSAs:
- People will be far less fearful of running out of money in their HSAs. The higher effective contribution limit and ability to roll over from FSAs and HRAs mean that people can "front-load" the accounts and have no fear of a catastrophic year.
- Banks and brokerage firms should have more incentive to open stand-alone HSA products. The higher probable deposit amounts mean that banks should begin to view these as the "new IRA."
- Employers will be more willing to offer HSAs. They will be able to plan ahead, contribute more to their lower earners, and have an easier transition out of traditional coverage or an HRA.
In short, this bill did for HSAs what EGTRRA and the PPA did for IRAs and 401(k)s. It took a good tax-advantaged product and made them superb.
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