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How to Avoid HSA and HRA Pitfalls and Traps: A Legal but Practical Perspective

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  1. How to Avoid HSA and HRA Pitfalls and Traps: A Legal but Practical Perspective Ashley Gillihan, Esq. Alston & Bird, LLP Ashley.gillihan@alston.com 404-881-7390

  2. Overview of Traps • Trap #1: ERISA Applicability • Trap #2: Nondiscrimination Rules • Trap #3: HRA Direct and Indirect Funding Rules • Trap #4: Disqualifying Coverage • Trap #5: New Contribution Rules under HR 6111 • Trap #6: Distribution Traps • Trap #7: Cafeteria Plan Issues • Trap #8: Prohibited Transaction Issues • Trap #9: Employee Cash Flow Concerns • Trap #10: Monitoring contributions • Other compliance issues

  3. HSA/HRA Traps and Pitfalls Trap #1: ERISA Applicability

  4. Trap #1: ERISA Applicability • ERISA Headaches—Why do we care? • DOL Guidance • Steps to avoid ERISA applicability

  5. Trap #1: ERISA Applicability • Headaches if ERISA applies . . . • Form 5500 • SPD and Plan Document • COBRA • Code’s COBRA provisions do not apply but ERISA may • HIPAA Privacy issues • Fiduciary Requirements • Code’s Prohibited Transaction Rules apply whether ERISA’s prohibited transaction rules apply or not • Class Action Litigation

  6. Trap #1: ERISA Applicability • Original view was that HSAs would be treated like IRA’s • IRAs that satisfy the following four “Safe Harbor” conditions are not subject to ERISA: • No contributions are made by the employer • Pre-tax contributions are employee contributions for DOL purposes • Participation is completely voluntary • The employer does not endorse the program • The employer receives no consideration other than reasonable compensation for services actually rendered • Same requirements apply to voluntary group insurance

  7. Trap #1: ERISA Applicability • DOL issued Field Assistance Bulletin (“FAB”) 2004-1: • Establishes “safe harbor” • DOL found that employer contributions were less significant in determining whether ERISA applies to HSAs so they tweaked the safe harbor to allow for employer contributions without triggering ERISA

  8. Trap #1: ERISA Applicability • Special Safe Harbor for HSAs • Employers may contribute to an HSA without triggering ERISA so long as the employer satisfies all of the following conditions: • Participation is completely voluntary • No restrictions on account holder’s ability to move funds to another HSA trustee • No restrictions on use of funds other than those permitted by code • Does not make or influence investment decisions • No “endorsement” by employer • Does not receive any payment or compensation

  9. Trap #1: ERISA Applicability • FAB 2006-02 clarifies aspects of FAB 2004-1 as well as other ERISA related issues • Employer may establish HSA on behalf of employee and make “employer” contribution w/o violating “completely voluntary” requirement • Salary reductions from employees must be voluntary in order to satisfy the safe harbor • ERISA is not triggered solely because employer chooses a particular vendor to whom it makes contributions.

  10. Trap #1: ERISA Applicability • FAB 2006-06 (cont’) • The employer does not “make or influence” investment decisions solely by choosing a vendor that offers same funds as employer’s 401(k) • FICA savings generated through cafeteria plan are not “compensation” to the employer • Employers can pay trustee/custodian fees directly without triggering ERISA • Employer/trustees can offer HSAs to its own employees without triggering ERISA so long as same product offered in normal course of business.

  11. Trap #1: ERISA Applicability • FAB 2006-06 (cont’) • Employer does receive “compensation” if it receives discount on services offered by vendor in conjunction with HSA • Failing to promptly forward contributions to trust is a prohibited transaction (even if ERISA does not apply) • IRA Class PT exemptions on free or reduced cost services not applicable to HSAs

  12. Trap #1: ERISA Applicability • Steps to avoid ERISA: • Include clear disclaimer regarding HSA status as an individual financial account – NOT an employer sponsored benefit plan • Review vendor materials • Review enrollment materials • Carefully draft HSA summaries • Review bundled arrangements • Look for potential discounts • Proceed with caution if choosing substituting 401(k) funds

  13. HSA/HRA Traps and Pitfalls Trap #2: Nondiscrimination Traps

  14. Trap #2: Nondiscrimination Traps • Tests Applicable to HSAs • Comparability • IRS guidance on comparability rule • Statutory improvements made by HR 6111 • Tests Applicable to HRAs • General 105(h) concepts • HIPAA Nondiscrimination

  15. Trap #2: Nondiscrimination Traps • What is the HSA “Comparability Rule”? • If an employer makes contributions to an individual’s HSA, it must make “comparable contributions” for all “comparable participating employees”

  16. Trap #2: Nondiscrimination Traps • What is the HSA “Comparability Rule”? • What are “comparable contributions” • The same amount or • The same percentage of the HDHP deductible covering the employee

  17. Trap #2: Nondiscrimination Traps • What is the HSA Comparability Rule? (cont’) • Who are comparable participating employees? • Employees of employers who are eligible individuals (as defined in Code Sec. 223) with the same level of coverage and fall into one of the following categories: • P/t employees • F/t employees • Former employees (other than those receiving COBRA coverage) • Employer may restrict HSA contributions to those who participate in the Employer’s HDHP • What about restrictions related to the HSA custodian chosen by employer?

  18. Trap #2: Nondiscrimination Traps • What is the HSA Comparability Rule? (cont’) • Permitted levels of coverage for purposes of comparability only: • Single • Family +1 • Family +2 • Family +3 or more • Amount for lower level cannot be more than next highest level of coverage

  19. Trap #2: Nondiscrimination Traps • What is the HSA Comparability Rule? (cont’) • Who is NOT a comparable participating employee? • Union employees • Partners/self-employed • Sole proprietors • Former employees receiving COBRA coverage under employer’s HDHP • With respect to contributions to non-HCEs, HCEs are not comparable participating employees (H.R. 6111)

  20. Trap #2: Nondiscrimination Traps • What is the HSA Comparability Rule? (cont’) • Comparability Rule measures amounts actually contributed during the calendar year (not just amounts “made available”) • HDHP plan year is irrelevant • Allows variations based on service during the year so long as everyone received the same monthly pro-rata amount • Employer agrees to contribute $100 per month to employees’ HSAs. • Bob is employed 12 months and Jim is employed 11 months. • Bob receives $1200 during the year and Jim only receives $1100. Is there a violation?

  21. Trap #2: Nondiscrimination Traps • What is the HSA Comparability Rule? (cont’) • Timing of contributions under Comparability Rule can be confusing. • Pay as you go • Allows me to stop making contributions during the year • Catch Up • Must track down former employees who were eligible individuals during the year • Pre-pay • May switch methods during the year but cannot stop making contributions

  22. Trap #2: Nondiscrimination Traps • What is the HSA Comparability Rule? (cont’) • Comparability rule DOES NOT APPLY to HSA contributions “made through the cafeteria plan” • When are contributions “made through the cafeteria plan”? • Pre-tax salary reductions • Matching contributions • Non-elective contributions to HSAs of those who were provided “opportunity” to make elective contributions through 125 plan • 125 discrimination rules apply.

  23. Trap #2: Nondiscrimination Traps • What is the HSA Comparability Rule? (cont’) • Recurring Issues and Concerns  • Part year employees • Last day of year vesting rule prohibited • What if HSA is never opened • What if opened with “other” trustee • Disease management programs and wellness program incentives

  24. Trap #2: Nondiscrimination Traps • HRA nondiscrimination traps: • Self-insured benefits cannot discriminate in favor of HCEs as to eligibility and benefits • Two tests: • Eligibility Test • Could be an issue if HRA offered only to a limited group consisting substantially of HCEs (top 25% in pay) • Contributions and Benefits Test • Pass test if same HRA accrual is made available to all participants for same contribution

  25. Trap #2: Nondiscrimination Traps • HRA nondiscrimination traps (cont’) • Plan Design issues: • Allowing only salaried to participate • Providing higher annual allocation to salaried than to hourly • Providing a higher annual allocation to those with more years of service or higher pay

  26. HSA/HRA Traps and Pitfalls Trap #3: HRA Direct and Indirect Funding Rules

  27. Trap #3: HRA Direct and Indirect Funding Rules • HRA cannot be funded by pre-tax salary reduction (including cashable Flex Credits) under a cafeteria plan • An HRA may be offered “in conjunction” with major medical plan under a cafeteria plan provided it is not funded directly or indirectly with pre-tax salary reductions

  28. Trap #3: HRA Direct and Indirect Funding Rules • Direct Funding: • Employees cannot elect to pay for HRA with pre-tax contributions • Salary reduction agreement should indicate that pre-tax contributions do NOT fund HRA • Salary reduction (and otherwise cashable credits) attributable to medical coverage cannot exceed applicable premium for non-HRA medical coverage • Applicable premium is determined using COBRA criteria (not including 2% admin charge)

  29. Trap #3: HRA Direct and Indirect Funding Rules • Indirect Funding: • No positive correlation between salary reduction for medical plan and HRA amount • Impermissible practices • HRA and salary reduction amount cannot increase or decrease in tandem • Option 1: HRA=$500/Salary Reduction=$300 • Option 2: HRA=$800/Salary Reduction=$500 • Cannot allow employees to elect to use HRA funds to pay for employer coverage in lieu of funding coverage via salary reduction • Cannot allow FSA forfeitures to fund HRA

  30. Trap #3: HRA Direct and Indirect Funding Rules • Indirect Funding (cont’) • Permissible practices • Variation between individual/family coverage • Single coverage/HRA of $500/Salary Reduction $300 • Family coverage/HRA of $700/Salary Reduction $500 • Threshold correlation (in/out HRA option) • Inverse Correlation • HRA amount for multiple options decreases (or increases) as salary reduction amount for multiple options increases (or decreases) • Option 1: HRA=$500/Salary Reduction=$300 • Option 2: HRA=$800/Salary Reduction=$200

  31. HSA/HRA Traps and Pitfalls Trap #4: Disqualifying Coverage

  32. Trap #4: Disqualifying Coverage • What is a Qualifying HDHP coverage? • Permissible benefits below HDHP deductible • The “Three P’s” • Preventive Care • Permitted Insurance • Permitted Coverage • Problem Area: State insurance mandates

  33. Trap #4: Disqualifying Coverage • General Rule • No coverage below deductible except for “three p’s” • Traps for the unwary participant • FSA/HRA general purpose coverage • Health FSA coverage with grace period • Executive medical (other than preventive) • Employer sponsored/on site clinics • Coverage under spouse’s plan

  34. Trap #4: Disqualifying Coverage • What is Preventive Care? • Code Section 223 does not specifically define “preventive care” • Notice 2004-23 provides safe harbor definition of “preventive care” • Preventive care includes, but is not limited to, • Periodic health evaluations and routine pre-natal and well-child care • Child and Adult immunizations • Obesity/Weight loss and Tobacco cessation programs • Screening services (specific list of permissible services provided)

  35. Trap #4: Disqualifying Coverage • What is preventive care? (cont’) • Preventive care DOES NOT include services that treat an existing condition • Ancillary medical procedures that are part of a preventive care service or program do not cause an otherwise preventive care service or treatment to fall outside of the safe harbor so long as it would be unreasonable or impractical to separate the medical procedure from the preventive care service or program • Removing polyps during a colon cancer screening procedure

  36. Trap #4: Disqualifying Coverage • What is preventive care? (cont’) • Drugs that constitute preventive care: A drug that satisfies any of the following 3 conditions is considered “preventive care” • Condition #1: • They are taken by an individual with risk factors for a condition that has not yet manifested itself or not yet become clinically apparent (the individual is asymptomatic) • Statins to lower cholestorol

  37. Trap #4: Disqualifying Coverage • What is preventive care? (cont’) • Drugs that are “preventive care” (cont’) • Condition #2: • They are taken by an individual to prevent the recurrence of a disease from which the person has recovered • ACE inhibitors for heart attack and stroke victims

  38. Trap #4: Disqualifying Coverage • What is preventive care? (cont’) • Drugs that are “preventive care” (cont’) • Condition #3: • The drugs are taken as part of a preventive care program • Drugs taken as part of a smoking cessation program or weight loss program

  39. Trap #4: Disqualifying Coverage • “Permitted coverage” is coverage for any of the following: • Dental • Vision • Long term care • Accidents • Disability • An example: school or sports accident/injury coverage

  40. Trap #4: Disqualifying Coverage • “Permitted Insurance” is: • Insurance where substantially all of the coverage relates to: • Workers’ compensation liability • Tort liabilities • Property/landowner liabilities • Insurance for a specified disease or illness • Insurance paying a fixed amount per day of hospitalization • e.g., Hospital Indemnity • Generally must be provided pursuant to a commercial insurance contract

  41. Trap #4: Disqualifying Coverage • PLR 200704010 regarding the 3 P’s: • coverage triggered solely by cancer (or another specified disease), including first occurrence benefits, progressive benefits, ROP benefits, and specified treatment indemnities triggered by cancer are permissible • preventive and screening benefits attached as riders to permissible benefits are permissible • a fixed indemnity policy with initial benefits triggered by heart attack, heart disease, or stroke is permissible (but no benefits are paid for any sickness, disease, or incapacity resulting from heart attack, heart disease or stroke) • fixed indemnities under HIP for treatment associated with a HIP such as surgery, ambulance, etc is not permissible • accident or disability only indemnities are permissible

  42. Trap #4: Disqualifying Coverage • Health FSA and HRA coverage • General Rule: Can’t be an Eligible Individual if you have general purpose Health FSA and/or HRA coverage (Rev. Rul. 2004-45).

  43. Trap #4: Disqualifying Coverage • Health FSA/HRA coverage (cont’) • Situations in which you can have Health FSA and still be an Eligible Individual • Health FSA coverage is limited to: • Expenses incurred after statutory minimum deductible is met (Post Deductible) • Pays after HDHP’s deductibles have been satisfied • Pays after own high deductible has been satisfied • Difficult Administration Issues • Certain permitted coverage expenses (i.e., vision/dental) • Preventive care • Difficult administration issues

  44. Trap #4: Disqualifying Coverage • Health FSA/HRA coverage (cont’) • Situations in which you can have HRA and still be an Eligible Individual • HRA coverage is limited to: • Expenses incurred after statutory minimum deductible is met (Post deductible) • Permitted coverage expenses (e.g., vision, dental) • Premiums for permitted insurance policies (e.g., specified disease or fixed indemnity per diem) • Preventive care • Suspended HRA • Retiree only HRA

  45. Trap #4: Disqualifying Coverage • Health FSA/HRA Coverage (cont’) • Dilemma regarding spouse’s health FSA coverage • E.g., Employee A has single HDHP coverage but is also covered under spouse’s employer’s general purpose Health FSA. • Plan sponsors could implement “single” and “family” Health FSAs • Administrative difficulties • Qualifying HDHP that is FSA or HRA must be accompanied by HDHP major medical coverage • I.e., High deductible Health FSA/HRA cannot be the only HDHP coverage • Health FSA Grace Period

  46. Trap #4: Disqualifying Coverage • Health FSA Grace Period: • Notice 2005-86 • if participant in general purpose Health FSA (w/ grace period) on last day of plan year (either active or COBRA qualified beneficiary), participant disqualified from HSA establishment until first day of first month following end of grace period EVEN IF ZERO BALANCE on last day of plan year or any time prior to end of grace period

  47. Trap #4: Disqualifying Coverage • Health FSA Grace Period (cont’) • Example of Notice 2005-86 rule: • Bob participates in calendar year Health FSA with 2 ½ month grace period ending March 15 of following year. Bob receives reimbursement for full election amount on December 15, 2007 so that he has $0 balance on December 31, 2007. • Although Bob has $0 balance, Bob is not eligible for an HSA until April 1, 2008. • Only solution provided under Notice 2005-86 was to convert FSA during grace period to limited purpose FSA for ALL HEALTH FSA PARTICIPANTS

  48. Trap #4: Disqualifying Coverage • Health FSA Grace Period (cont’) • New rule under HR 6111 • Grace period does not disqualify an individual if individual has zero balance on last day of plan year • This can be accomplished in one of two ways: • Spend funds down prior to end of the plan year • Make the one time tax free rollover under applicable rules (see Trap #5)

  49. Trap #4: Disqualifying Coverage • Health FSA Grace Period (cont’) • Good news: • Provides relief from Notice 2005-86 impediment • Allows Bob to establish HSA on January 1, 2008 instead of April 1, 2008 • Bad news: • Encourages end of year “unnecessary” spending (the very thing the grace period avoided)

  50. Trap #4: Disqualifying Coverage • What about EAPs, wellness and disease management? • Participation in employee assistance programs (EAPs), wellness programs and disease management programs do not disqualify an otherwise eligible individual so long as the programs are not considered “health plans” for HSA purposes • Such a program is not a “health plan” if it does not provide significant benefits in the nature of medical care or treatment