Recent Guidance on Health Savings Accounts

Health Savings Accounts (“HSAs”) were introduced in December 2003 as part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the “Act”). We described the main features of HSAs in our January 2004 issue of Benefits Report, available at

Since HSAs were introduced, the Internal Revenue Service and the Department of the Treasury have issued a flurry of substantive guidance to help individuals, plan sponsors, and service providers understand how HSAs may be established and operated. This guidance includes (in order of date issued): Internal Revenue Notice 2004–2, Internal Revenue Notice 2004–23 (“Notice 2004–23”), Internal Revenue Notice 2004–25 (“Notice 2004–25”), Revenue Ruling 2004–38, Revenue Procedure 2004–22, Revenue Ruling 2004–45, Internal Revenue Notice 2004–43, and Internal Revenue Notice 2004–50. In addition, on April 7, 2004, the Department of Labor (the “DOL”) provided guidance in the form of Field Assistance Bulletin 2004–1 (“FAB 2004–1”).

While we do not attempt to describe all of the substantive provisions addressed in the recent guidance, the following highlights issues we believe will be of particular interest to plan sponsors and service providers that are considering offering HSAs and/or their companion high deductible health plans (“HDHPs”).

Timing of HSA Contributions
HSA contributions for a particular year, whether they are made by the individual or on the individual’s behalf (for example, by the employer), may be made at any time prior to the due date (without extension) of the eligible individual’s federal tax return for that year. Thus, a calendar year taxpayer who is an “eligible individual” throughout 2005 may make HSA contributions for 2005 at any time between January 1, 2005 and April 15, 2006 (to be considered an “eligible individual,” the individual must, among other requirements, be enrolled in an HDHP). These contributions can be made in one or more payments. However, whether an individual is an eligible individual for HSA contribution purposes is determined on a monthly basis. Thus, if the entire year’s contributions are funded at the beginning of the year and the individual is not an eligible individual for the entire year, the HSA would have excess contributions. Excess contributions must be timely corrected or an excise tax of 6% applies to the excess. Correction of an excess contribution is accomplished by payment of the excess (and the net income attributable to the excess) to the account beneficiary who must include this amount in gross income in the year of the correction.

Timing of HSA Qualified Medical Expenses
HSAs may be used to pay for the account beneficiary’s qualified medical expenses (defined as Code section 213(d) medical care for the account beneficiary or his or her spouse or Code section 152 dependents, so long as the amounts are not paid by insurance or otherwise) incurred after the HSA is established. Once an HSA is established, distributions from the HSA may be used to pay for qualified medical expenses incurred even after the account beneficiary is no longer an eligible individual (for example when the account beneficiary becomes eligible for Medicare).

The IRS issued transition relief for 2004 because “many taxpayers who otherwise would be eligible to establish and contribute to HSAs have been unable to do so because they cannot locate trustees or custodians who are willing and able to open HSAs at this time.” Notice 2004–25 provides that, for calendar year 2004 only, so long as an eligible individual establishes an HSA for 2004 on or before April 15, 2005, that HSA may be used to pay or reimburse the eligible individual for qualified medical expenses incurred on or after the later of January 1, 2004, or the first day of the month in which the account beneficiary became an eligible individual. However, for HSAs established for 2005 and later, the medical expenses must be incurred on or after the date the HSA is established in order to be paid or reimbursed from the HSA.

HSA Contributions Are Nonforfeitable Even When Made by an Employer
An HSA is a trust established for the purpose of paying for qualified medical expenses. Any contribution made to an HSA immediately becomes the nonforfeitable interest of the account beneficiary regardless of who—including the account beneficiary’s employer—makes the contribution to the HSA on that individual’s behalf. Thus, an employer may not recoup any of the contribution made to the HSA. The IRS offers the following as an example: “[On] January 2, 2005, the employer makes the maximum annual contribution to employees’ HSAs, in the expectation that the employees would work for the entire calendar year 2005. On February 1, 2005, one employee terminates employment. The employer may not recoup from that employee’s HSA any portion of the contribution previously made to the employee’s HSA.”

In addition, HSA contributions may be used by the account beneficiary for purposes other than to reimburse or pay qualified medical expenses, and an employer contributing to an HSA may not impose restrictions on the use of such contributions. However, unless the distribution is made after the account beneficiary’s death, disability or attainment of age 65, any amount not used exclusively to pay for qualified medical expenses would be includable in the account beneficiary’s gross income and a 10% excise tax on that amount will apply.

Other Considerations for Employers Who Contribute to HSAs
If an employer decides to contribute to an HSA, the employer’s responsibilities for determining whether an employee is an eligible individual are limited to the following:

  • The employer must determine whether the employee is covered by an HDHP sponsored by the employer; and
  • The employer must determine whether the employee is also covered by a plan sponsored by the employer that is not an HDHP (e.g., a health flexible spending account) that disqualifies the employee from being an “eligible individual” for HSA contribution purposes; and
  • The employer must determine the employee’s age (and may rely on the employee’s representation of his date of birth) for purposes of allowing catch-up contributions under the HSA rules.

If an employer makes HSA contributions on behalf of its employees, those contributions must be comparable — generally, contributions of the same amount or the same percentage of the annual deductible limit of the HDHP covering employees enrolled in the same category of coverage. However, these comparability rules do not apply to contributions made through a cafeteria plan; such contributions are instead subject to the Code section 125 nondiscrimination rules.

Clarification of the Preventive Care Safe Harbor
An HDHP must have a minimum annual deductible of $1,000 for self-only coverage and $2,000 for family coverage. However, the Act provides a safe harbor exception which allows certain preventive care to be provided under an HDHP before the minimum HDHP annual deductibles are satisfied. For this purpose, the IRS has stated that “preventive care” generally includes, but is not limited to, the following:

  • Periodic health evaluations, including tests and diagnostic procedures ordered in connection with routine examinations, such as annual physicals.
  • Routine prenatal and well-child care.
  • Child and adult immunizations.
  • Tobacco cessation programs.
  • Obesity weight-loss programs.
  • Screening services.

The Appendix to Notice 2004–23 includes a comprehensive list of permissible screening services categorized under the following: cancer; heart and vascular diseases; infectious diseases; mental health conditions and substance abuse; metabolic, nutritional, and endocrine conditions; musculoskeletal disorders; obstetrical and gynecological conditions; pediatric conditions; and vision and hearing disorders.

Preventive care does not include “any service or benefit intended to treat an existing illness, injury, or condition.”

Interaction Between HSAs and Prescription Drug Benefits
The HSA rules require that an eligible individual must be covered by an HDHP, and cannot at the same time be covered by another health plan that is not an HDHP unless that plan primarily provides permitted coverage (accident, disability, dental, vision or long-term care insurance) or permitted insurance (generally, workers’ compensation, tort liability, and property insurance; or insurance covering a specific disease or illness, or hospitalization). Prescription drug benefits are often provided by employers through a separate plan, or as a rider to the medical coverage provided under a health plan. In addition, like preventive care described above, prescription drug benefits are often subject to a lower deductible than are medical benefits, or subject to no deductible at all. However, unlike preventive care, the Act does not provide a safe harbor exception for prescription drugs.

Revenue Ruling 2004–38 confirms that a plan that provides prescription drug coverage is a health plan. However, because prescription drug coverage is neither permitted coverage nor permitted insurance, the prescription drug benefits must be provided subject to the minimum HSA deductible requirements ($1,000 / 2,000) or the individual enrolled in such coverage will not be considered an eligible individual under the HSA rules.

Recognizing that plan sponsors may not have had adequate time to redesign their prescription drug benefits to conform to the HDHP requirements, the IRS has provided transition relief through December 31, 2005. This transition relief applies for those “individuals who would otherwise qualify as eligible individuals but for the coverage by a prescription drug benefit provided under a separate plan or rider that is not an HDHP.” Under this transition provision, an individual who is covered by an HDHP but is ineligible to contribute to an HSA solely because he or she is also covered by a prescription drug plan or rider that is not an HDHP may continue to make contributions to an HSA based on the annual deductible of the HDHP. Note that this provision will cease to apply effective January 1, 2006.

HSAs’ Interaction with FSAs and HRAs
As described above, to be eligible to contribute to an HSA, an individual must be enrolled in an HDHP. Revenue Ruling 2004–45 discusses the implications for an individual who is also enrolled in a health flexible spending arrangement (“FSA”) and/or a health reimbursement arrangement (“HRA”) during a particular month. Coverage under the FSA and/or the HRA would generally be considered coverage under a health plan that is not an HDHP; thus an individual who participates in the FSA and/or HRA would be ineligible to contribute to an HSA for that month.

Rev. Rul. 2004–45 offers plan sponsors some design flexibility by describing a number of arrangements in which an individual participating in an FSA and/or HRA may still be considered an eligible individual for purposes of contributing to an HSA. For example, the FSA or HRA could be designed to cover only certain permitted coverage (dental and vision only, for example) so as not to disqualify the individual as an eligible individual. The IRS refers to these as “limited-purpose” FSAs and HRAs. Alternatively, the FSA and/or HRA could be designed so as not to reimburse any medical expenses incurred until the HDHP minimum annual deductible ($1,000 or $2,000, as applicable) is met. The HRA could also be designed as a “retirement HRA” which only pays or reimburses medical expenses incurred after retirement, so the individual could contribute to an HSA before retirement. Any combination of these arrangements is permissible so long as the resulting design would not otherwise disqualify an individual from contributing to an HSA.

Coverage Under an Employee Assistance, Disease Management, or Wellness Program
The IRS has indicated that an individual may still participate in an HSA even if he or she is covered under an employee assistance program (“EAP”), disease management program, or wellness program, as long as such program is not considered a “health plan” under the HSA rules (i.e., the program must not provide “significant benefits in the nature of medical care or treatment”). As an example of an EAP that is not a health plan for purposes of the HSA rules, the IRS describes an EAP that provides free or low-cost short-term counseling to identify and address (or provide referrals for) an employee’s problem that may be affecting his or her job performance, including, but not limited to, “substance abuse, alcoholism, mental health or emotional disorders, financial or legal difficulties, and dependent care needs.”

The IRS has similarly provided an example of a disease management program that would not be considered a “health plan” under the HSA rules as a program “that identifies employees and their family members who have, or are at risk for, certain chronic conditions. The disease management program provides evidence-based information, disease specific support, case monitoring and coordination of the care and treatment provided by a health plan. 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.”

A wellness program that would not be considered a “health plan” by the IRS is a program that provides services—such as education, fitness, sports, and recreation activities, stress management and health screenings—designed to help improve employees’ overall health and prevent illness.

HSA Election Changes Under the Code Section 125 Change in Status Rules
For HSA contributions made through a cafeteria plan, the status change rules under Code section 125 apply (see Treasury Regulations section 1.125–4). Those rules allow an employee to make election changes during a “period of coverage” only under certain circumstances. Because HSA eligibility and contribution limits are determined on a month to month, rather than an annual basis, the HSA period of coverage is a calendar month. As a result, an eligible individual may prospectively start, stop, increase, or decrease his election effective at the beginning of any month, the employer’s cafeteria plan permitting. Any cafeteria plan restrictions imposed on HSA contribution changes must be applied consistently to all employees.

Permissible Rollover Contributions
An HSA may accept rollover contributions only from Archer MSAs and other HSAs. Rollovers from Individual Retirement Accounts (IRAs), HRAs, or FSAs are not permitted.

While an HSA account beneficiary may make only one rollover contribution to his or her HSA during a one-year period (and such rollover must be made within 60 days of the distribution from the eligible account), there is no limit on the number of trustee to trustee transfers of HSA assets.

Disposition and Tax Treatment of HSAs Upon Death of the Account Beneficiary
Upon the death of the account beneficiary, if the named beneficiary is the account beneficiary’s surviving spouse, the HSA will become the surviving spouse’s HSA, and all the usual HSA rules apply. However, if the named beneficiary is someone other than the surviving spouse, the HSA ceases to be an HSA as of the date of the account beneficiary’s death. In this case, the named beneficiary is required to include in his or her gross income the fair market value of the HSA assets as of the date of the account beneficiary’s death. This amount may be reduced by any payments made by the HSA for the decedent’s qualified medical expenses, so long as such payments are made within one year following the date of death.

The Application of ERISA to HSAs
FAB 2004–1 provides that the DOL will not consider an HSA to be an “employee welfare benefit plan” under Section 3(a) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), even if the employer contributes to the HSA, as long as the employer’s involvement in the HSA is limited. Accordingly, the requirements of ERISA Title I, including, but not limited to, the reporting and disclosure requirements (for example, the Form 5500 Annual Report filing and the summary plan description production and distribution requirements) would not apply to HSAs if employer involvement is so limited.

According to the DOL, if employer involvement is to be considered limited, the establishment of an HSA must be completely voluntary on the part of the employee, and the employer must not do any of the following:

  • limit the ability of eligible individuals to move their funds to another HSA beyond restrictions imposed by the Code;
  • impose conditions on utilization of HSA funds beyond those permitted under the Code;
  • make or influence the investment decisions with respect to funds contributed to an HSA;
  • represent that the HSAs are an employee welfare benefit plan established or maintained by the employer; or
  • receive any payment or compensation in connection with an HSA.

According to the DOL, an employer may “impose terms and conditions on contributions that would be required to satisfy tax requirements under the Code” and limit contributions through its payroll system to a particular HSA provider, or even limit the HSA providers who market their products through the workplace, without implicating ERISA’s application. FAB 2004–1 cautions, however, that an employer-sponsored HDHP is still a group health plan under ERISA (unless otherwise exempted), even if an HSA offered in conjunction with that HDHP is not.

Link to HSA Guidance
Other than the DOL’s FAB 2004–1, all of the technical guidance discussed in this article is available at This Treasury page also provides a list of frequently asked questions, and links to HSA-related IRS forms published to date, press releases, and other HSA information and resources.

FAB 2004–1 is available at–1.html.