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Introduction to Health Savings Accounts (HSAs)

Learn how a health savings account (HSA) lets you pay for medical expenses with tax-free dollars.

Introduced in 2004, health savings accounts (HSAs) have become a popular option for those who are not insured under a traditional health plan. The account, when combined with the required high deductible health insurance plan, allows consumers to save for future medical expenses with tax-free dollars.

Though using an HSA along with a high deductible health insurance plan can bring down the overall cost of health care for some people, it's not the best option for everyone. Before considering an HSA for yourself or your family, learn how the accounts work, who can participate, how much you can contribute, and what your out-of-pocket costs could be.

What Is a Health Savings Account (HSA) and a High Deductible Health Plan (HDHP)?

An HSA is a special account into which you deposit pre-tax money for the purpose of paying future medical expenses for yourself or your family. Before you can establish an HSA, you must enroll in a high deductible health plan (HDHP), sometimes called a "catastrophic" health plan.

With an HDHP, you will pay lower premiums but higher annual deductibles and out-of-pocket maximums than you would with a traditional health plan. You must meet your deductible before your HDHP begins covering your medical expenses. Once your deductible is met, your plan, typically, will pay a percentage of your medical costs until you reach your out-of-pocket maximum. After you have spent the maximum amount, the HDHP will pay 100% for in-network covered services.

Combined, the HSA and HDHP offer an alternative to traditional health insurance that better meets the needs of some individuals and families.

These are some of the advantages an HSA/HDHP plan offers:

Lower fixed cost. HDHP premiums are typically much lower than those for other health plans because HDHPs do not pay for the first several thousand dollars of medical expenses. The idea is that the money you save on premiums can be used to fund your HSA, which you will tap to pay for all medical expenses not paid by the health plan.

Tax savings. First, as an HSA owner, you can make pre-tax contributions to your account, or you can deduct your post-tax contributions from taxable income on your Form 1040, whether or not you itemize deductions. Second, you will enjoy tax-free interest earnings and investment growth within your HSA. And third, you can withdraw money from your HSA tax-free to pay for qualified medical expenses. (For more information about HSAs and taxes, read IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans. To order the publication, call 800-TAX-FORM or visit the IRS online, at State tax treatment of HSAs varies.

Account ownership. Unlike a health reimbursement arrangement (HRA), which is owned by a sponsoring employer, you own your HSA. That means the account goes with you when you leave the company, even if it was established and funded as an employer-sponsored benefit.

Unlimited accrual. Whereas a flexible spending account (FSA) requires participants to "use or lose" their account contributions each year, an HSA allows unused funds to roll over from year to year. There is no limit on how much you can accumulate in your HSA for future use.

Eligibility Requirements for an HSA

To be eligible for an HSA, you:

  • must be covered by a qualified high deductible health plan that for 2010 has a deductible of at least $1,200 for individuals and $2,400 for families (some plans offer a no-deductible or low-deductible benefit for preventive care only); your annual out-of-pocket expenses, including deductibles and copays, cannot exceed $5,950 (self only) and $11,900 (families), but if yours is a network plan, it may apply higher out-of-pocket limits for non-network services
  • cannot be covered by any other insurance that would pay for medical expenses, except those that provide benefits only for the following items: accidents, dental care, vision care, disability, long-term care, worker's compensation, and specific disease or illness, if the policy pays a specific dollar amount on claims
  • must be younger than age 65 (not eligible for Medicare benefits)
  • can't be claimed as a dependent by someone else
  • do not have to have employment income, and
  • can earn any amount -- there are no income limits for HSA eligibility.

You may or may not be eligible for an HSA if your employer offers a flexible spending account or a health reimbursement arrangement (HRA); it depends on the particular FSA or HRA the company offers.

The best way to determine if you meet all HSA eligibility requirements is to consult an insurance professional or other HSA advisor before establishing your account.

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