10/12/07

Diana Theis Consultant, IRAs/HSAs, Wolters Kluwer Financial Services

Health Savings Accounts (HSAs) allow eligible individuals to make tax-deductible contributions and use the accumulated assets to pay for qualified medical expenses on a tax-free basis. Determining the appropriate contribution amount is an HSA owner’s responsibility. However, to administer HSAs effectively, an HSA custodian/trustee should have a basic understanding of the contribution limits and eligibility rules. This article will review the basic eligibility requirements and the rules that apply when an HSA owner determines his/her HSA contribution amount each year.

Eligibility
An eligible individual is someone covered under a high-deductible health plan (HDHP) with no other health plan coverage other than certain permitted coverage. He/she cannot be eligible to be claimed as a dependent on someone else’s tax return and cannot be enrolled in Medicare. HDHP requirements are subject to cost-of-living adjustments (COLAs).

HDHP Requirements
Tax Year	HDHP Coverage	Minimum Deductible	Out-of-Pocket Expense  Limit
2007	Self-Only	$1,100	$5,500
	Family	$2,200	$11,000
2008	Self-Only	$1,100	$5,600
	Family	$2,200	$11,200

Regular and Catch-Up Contributions
Regular contribution limits are dependent on HDHP coverage, either self-only or family. The rules define family coverage as “any coverage other than self-only coverage,” which includes the HDHP eligible individual and one or more other individuals. The other individual may or may not be the HDHP insured’s spouse.

Individuals age 55 or older (and not enrolled in Medicare) may contribute an additional amount referred to as a catch-up contribution.

Regular contribution limits are subject to COLAs. The catch-up contribution limit increases to $1,000 in 2009.

An employer HSA contribution or an HSA contribution from an individual’s traditional or Roth Individual Retirement Account (IRA) is considered a regular or catch-up contribution.

HDHP Contribution Limits
Tax Year	HDHP Coverage	Standard Limit	Catch-Up Contribution	Total Contribution Limit Age 55 and Older
2007	Self-Only	$2,850	$800	$3,650
	Family	$5,650		$6,450
2008	Self-Only	$2,900	$900	$3,800
	Family	$5,800		$6,700

Monthly Eligibility
If an individual has HDHP coverage on the first day of the month, he/she is eligible for a contribution for that month. Without HDHP coverage on the first day of the month, no HSA contribution is possible for that month. Both regular and catch-up contribution limits are pro-rated to determine the monthly contribution limit.

However, an exception exists for an individual’s first year of HSA eligibility. See First Year of HSA Eligibility later in this article.

Examples
Amy has HDHP self-only coverage for seven months during 2007. Because Amy is eligible for only seven months, she is eligible for an HSA contribution of $1,662.50, which is seven-twelfths of the 2007 annual contribution limit.

James, age 57, has HDHP family coverage for three months during 2007. James is eligible for a regular HSA contribution of $1,412.50, which is three-twelfths of $5,650, plus a $200 catch up contribution, which is three-twelfths of $800, for a total contribution amount of $1,612.50.

Exception for First Year of HSA Eligibility
The Health Opportunity Patient Empowerment (HOPE) Act of 2006 enhanced an individual’s ability to make an HSA contribution if he/she is not eligible for the entire year. For his/her first-year of HSA eligibility, an individual who is eligible on December 1 may contribute an amount equal to coverage for a full year, even if he/she is otherwise eligible for only part of the year due to HDHP coverage status.

If he/she does not maintain HDHP coverage through a testing period—December 1 of the first year of coverage through December 31 of the following year—any amount contributed for months of ineligibility is taxable and subject to a 10 percent penalty tax.

Example
Joel, age 26, has self-only HDHP coverage beginning September 1, 2007, and is still eligible as of December 1, 2007. Since 2007 is his first year of coverage, he may contribute $2,850. If Joel does not maintain HSA eligibility from December 1, 2007 through December 31, 2008, any amount that he contributes over $950 ($237.50 monthly x 4 months) is subject to income tax and a 10 percent penalty tax.

HSA Contribution Rules for Married Couples
Various situations can affect the contribution limit for married couples in a number of ways, as explained in the scenarios that follow. Even if one spouse is not eligible to establish and fund his/her own HSA, the couple may pay for his/her qualified medical expenses from the other spouse’s HSA. See IRS Revenue Ruling 2005-25 for more married couple HSA contribution examples.

Scenario 1
Phil has an HDHP with family coverage that includes his wife, Karen. Neither of them have any other health insurance, or are enrolled in Medicare. Phil and Karen may each establish an HSA and contribute to it because they are each eligible individuals. The family coverage limit for 2007 is $5,650, which is their combined HSA contribution limit. They may divide that amount in any manner they decide, including contributing the full $5,650 to just one HSA.

If Phil or Karen is age 55 or older by the end of the year, he/she is eligible for a catch-up contribution of $800, which must be made to his/her own HSA.

Scenario 2
Jim and Debbie have separate HDHPs with family coverage that cover each other. The contribution limit is the same as Scenario 1. Jim and Debbie may split the family coverage amount between their HSAs in any manner they decide.

Scenario 3
Mike and Janelle, a married couple, each have a separate HDHP with self-only coverage. Mike and Janelle are each eligible to open an HSA and contribute the self-only limit for 2007, $2,850 each for a total of $5,700. They are not eligible to divide the $5,700 between their HSAs in any other manner.

Scenario 4
Diana has an HDHP with family coverage that covers her husband, Tom. Tom has a separate HDHP with self-only coverage. Both Diana and Tom can establish an HSA. However, their combined HSA contribution cannot exceed the family coverage limit, plus catch-up, if applicable.

Scenario 5
Steve has an HDHP with family coverage and his wife Loree has non-HDHP with self-only coverage. Steve is eligible to establish an HSA and contribute up to the family coverage limit. Loree is covered under Steve’s HDHP, but she is not eligible for an HSA contribution because she is also covered by a non-HDHP.

Change in Coverage
If there is a change in HDHP coverage type during the year, the monthly contribution is determined according to the coverage type on the first day of the month.

Example
Kate, age 26, has self-only HDHP coverage, making her monthly contribution $237.50 ($2,850 divided by 12). Kate married Nick on June 15 and changed to family coverage on July 1 to include Nick. Kate’s HDHP family coverage allows a monthly contribution of $470.83 ($5,650 divided by 12). Kate may contribute $1,425 (six-twelfths of $2,850) for January through June. Kate and Nick are eligible for HSAs and may contribute $2,825 (six-twelfths of $5,650) between their HSAs for July through December.

Archer Medical Savings Accounts
Archer Medical Savings Account (MSA) contributions made for a tax year reduce the allowable HSA contribution for the same year.

Example
Bob, age 47, is an eligible individual and has self-only coverage under an HDHP beginning January 1, 2007. Bob made a $1,000 Archer MSA contribution for 2007. Because of that, he may contribute only $1,850 to his HSA for 2007.

IRA to HSA Transactions
An HSA owner may take a one-time (once-in-a-lifetime) traditional or Roth IRA distribution to fund an HSA (a qualified HSA funding distribution). These contributions are considered regular, current-year HSA contributions and therefore cannot exceed an HSA owner’s contribution limit for the year. They also reduce the amount an individual may otherwise contribute to an HSA for the year and are not deductible HSA contributions. This provision does not apply to distributions from a simple employee pension (SEP) plan or Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) IRAs.

The IRA distribution is tax free as long as an HSA owner remains an eligible individual during the testing period. The testing period begins with the month of the contribution to the HSA and ends on the last day of the twelfth month following such month.

Failure to remain an eligible individual for the entire testing period subjects the IRA-funded amount to income tax and a 10 percent penalty tax in the tax year he/she becomes ineligible. However, no income tax or penalty tax applies if loss of eligibility is due to death or disability.

Example
Harold, age 58, has a $6,700 HSA contribution limit for 2008. On June 1, 2008, Harold funded his HSA with a $5,000 tax-free distribution from his traditional IRA. Because of that, he may only contribute an additional $1,700 to his HSA for 2008 ($6,700 − $5,000). The testing period begins June 1, 2008, and ends June 30, 2009. If Harold drops his HDHP coverage in February 2009, the IRA distribution amount will be subject to tax and a penalty tax in 2009.

An IRA custodian/trustee reports a qualified HSA funding distribution based on an individual's age, either younger than age 59½ or already age 59½.

Making HSA Contributions
Although contribution eligibility is determined as of the first day of each month, an individual may contribute the total annual amount at any time between January 1 and his/her tax-filing due date for that year, excluding extensions. This may require a corrective distribution if the HSA owner is not eligible for the entire year. It could result in tax and penalty tax if an individual takes advantage of the first year eligibility rule and fails to maintain coverage during the applicable testing period.

Reporting HSA Contributions
Any individual or employer may contribute to an HSA. An HSA trustee/custodian does not have to track the identity of a contributor since it reports the total contribution amount on IRS Form 5498-SA, HSA, Archer MSA, or Medicare Advantage MSA Information, in Box 2.

Example
Deloris has an HDHP with self-only coverage. Her employer contributed $500 to her HSA, another $500 came from Deloris’s IRA, and Deloris contributed an additional $1,850. Deloris’s HSA custodian/trustee will report the total contribution amount of $2,850 on Form 5498-SA in Box 2.

Custodian Responsibility
Who is responsible for determining how much an individual can contribute to his/her HSA? Each HSA owner.

An HSA custodian/trustee must not accept more than the annual limit for family coverage plus the catch-up amount. For 2007, that amount is $6,450, the family coverage limit of $5,650 plus the catch-up amount of $800. An HSA custodian/trustee is not responsible for determining if any individual’s contribution limit is less than this amount.

Example
Amy wants to make a $6,450 HSA contribution for tax year 2007, which her custodian can accept because it is not more than the maximum contribution amount for 2007. However, if Amy has self-only coverage, is younger than age 55, or is not eligible for the entire year, it is up to Amy to determine the correct contribution amount, not her HSA custodian/trustee.

Conclusion
HSA activity is on the increase, which means more accounts and more contributions each year. HSA contribution decisions can be complicated because of the multiple variables. An HSA custodian/trustee needs to understand the basics to effectively administer the accounts. However, perhaps the best information that an HSA custodian/trustee can provide is to direct HSA owners and their tax professionals to IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, and to IRS Form 8889, Health Savings Accounts (HSAs), and its accompanying instructions, for specific contribution calculations and advice.