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Congress charts big changes for HSAs: Bush signs them into law

By Rob Smith, Ceridian manager of Government Relations

"These changes will bring health savings accounts within the reach of more of our citizens, and ensure that more Americans can get the quality care they deserve." - President George Bush, December 20, 2006

After a long year of partisan gridlock and political shenanigans, the 109th Congress ended with a flurry of legislative activity the likes of which we seldom see. In addition to approving a wide variety of major trade bills, extending tax credits for everything from R&D to teachers' school supplies, and staving off a huge cut in Medicare reimbursements for physicians, Congress passed a significant revision of Health Savings Account (HSA) rules.

HSAs have been a hallmark of the Bush administration and the efforts of the Republican Congress to reduce health insurance costs for employers and workers, and over three million Americans have enrolled in HSAs. Nevertheless, while HSA growth has been rapid since they became available in January 2004, fewer than four percent of those who obtain health insurance from their employers have adopted the plans.

HSAs and the High Deductible Health Plans (HDHP), with which they are paired, have true potential to save employers and their employees money. Health plans with a high deductible have much lower premiums than traditional plans, and HSAs provide a completely tax-free savings vehicle enrollees can use to pay the plan deductible and their other out-of-pocket health costs. However, many of the government regulations and contribution limits under previous HSA law contributed to their relative lack of popularity among other health care coverage options.

The Tax Relief and Health Care Act of 2006 (H.R. 6111), which President Bush signed into law on December 20, amends many of the more troublesome aspects of HSAs and aims to make them a more attractive option for workers and businesses who struggle under the expense of traditional health insurance.

To the limit
A regulation that tied maximum annual HSA contributions to a participant's health plan deductibles was one of the main drawbacks to enrolling in HSA-eligible coverage. For 2007, HSA holders can contribute up to $2,850 for individual coverage or $5,650 for family coverage to their accounts. However, under previous law, if an individual's plan deductible was less than the maximum HSA contribution amount, they could only match the deductible. For example, a family with a plan with an annual deductible of $3,000 could only contribute $3,000 for that year -- $2,650 less than the $5,650 annual HSA maximum for family coverage. In effect, people who considered signing up for an HSA had to choose between a plan that would allow them to save the most money and a lower deductible plan that would give them greater insurance coverage and less out-of-pocket costs.

The new law repeals the deductible limit, allowing all HSA participants to max out their accounts regardless of their plan deductible. Now that individuals are free to choose a low deductible plan that matches their health care needs, while at the same time saving more money in their HSA accounts to help cover their medical expenses, much of the anxiety regarding the coverage these plans offer has been removed.

More flex in Flexible Spending Accounts
In addition, the law permits HSA holders to make a one-time transfer from their Flexible Spending Accounts (FSA), Individual Retirement Accounts or Health Reimbursement Accounts to help fund their HSAs.

FSA owners in particular will benefit from this provision. Oftentimes, at the end of the year, employees have money left in their FSAs. Under the IRS's "use it or lose it" rule, any unspent FSA funds at year-end are forfeited to the employer. Now, under the new law, FSA holders will be free to transfer their unspent FSA money to an HSA. While the HSA transfer can only be made once, this provision is an important step toward a more complete adjustment of the "use it or lose it" rule to allow FSA participants to carry forward their account balances from year to year. In addition, since HSA regulations stipulate that employees cannot hold an HSA and a standard FSA simultaneously, except a "limited purpose FSA," this provision will make it easy for current FSA holders to switch over to an HSA-eligible health plan -- all with the bonus of avoiding the "use it or lose it" penalty.

Enroll at any time
The new law also significantly improves HSAs for individuals who enroll after the start of the plan year. Previous HSA regulations limited contributions to the months that an individual has qualifying HDHP coverage, with the total contribution pro-rated for each month of the full plan year. In effect, people who enrolled after the beginning of the year could only contribute for the months in which they have an HSA. For example, an individual who began their HSA coverage at the beginning of the plan year would typically contribute $237.50 each month to reach the full annual maximum of $2,850 (2,850 / 12 = 237.50). However, if the employee enrolled in HSA coverage in December, they could only put $237.50 in the account for the year. And even though he was limited to the one-twelfth contribution, they would still have to fulfill the full annual deductible on their HDHP before the coverage would kick in.

Clearly, it's hardly fair to subject these enrollees to a full yearly insurance deductible requirement while denying them a full year's contribution to an account that is supposed to help them cover the deductible expense. Under the new rules, individuals who enroll in an HSA after the start of the year can still contribute up to the full annual maximum, regardless of what month they enroll. This provision will fix this glaring inequity and establish an important balance between HSA account security and HDHP coverage.

From a payroll compliance perspective this change could prove tricky to administer. New HSA enrollees will be able to pro-rate their annual tax-deductible contribution over the remaining months of the year, but will need to adjust the monthly contribution at the start of the new year to a 12-month cycle.

In addition, the new law requires part-year HSA participants to remain in an HSA-qualified HDHP for 12 months following the first monthly contribution. The new law is not clear how the 12-month continuance provision is to be enforced.

Paving the way
The federal government has invested a lot of effort in promoting HSAs and making them work. The new law makes many significant changes to move this coverage model forward. Health insurance is without a doubt the most important benefit employees have, and it's a big step for them to adopt an unconventional plan. However, as premiums for traditional plans continue to rise, HDHP costs have remained relatively low and stable. And when one considers that these low premiums come with a completely tax-free, portable, savings account, it's easy to see the potential in HSAs. Human nature dictates that consumers will always be wary of new products. Just as it's wise to wait for the second generation of a new model car, employees and businesses have been right to greet HSAs with a healthy degree of skepticism so far. But now that many of the concerns regarding how HSAs are structured and the plan limitations have been addressed, the road ahead for their success looks a lot smoother. Many of these changes will be implemented in 2007, so be on the lookout for a progress report from Ceridian Government Relations.