How health savings accounts (HSAs) work
HSAs can be a wonderful supplement to certain health insurance programs for a few reasons. First, your balance and earnings are tax-deferred and, all funds used directly for medical expenses become tax-free.
Second, you can continue to add to your account and carry over balances from year-to-year, even eventually using these funds to supplement your retirement earnings if you have a balance after medical expenses are paid.
Finally, using an HSA allows you to save insurance premiums because you can select a High Deductible Health Plan (HDHP), much less costly than a full-service traditional health insurance policy.
HSAs must be "matched" with HSA-compatible health insurance plans to work properly. All insurance companies offer HSA-qualified health plans. You can take the cost savings offered by an HDHP versus a traditional health insurance plan and deposit these funds into an HSA, which you can open at most banks and credit unions.
The maximum allowable contribution for 2009 is $3,000 for individuals and $5,950 for families. If it sounds like HSAs are similar to IRAs, you're correct. They work much the same way.
For income tax purposes, you can deduct the amount you deposit in your HSA just as you would an IRA contribution. Both the money you deposit and the interest you earn is, at least tax-deferred, often becoming tax-free, depending on your usage of these funds.
You may use this money for every-day medical expenses and to meet the larger deductibles of your HDHP. Using your HSA for these purposes preserves the tax-free nature of these funds.
For example, you have $1,700 in your HSA and you need a test costing $1,000. Your HDHP will pay $650 towards the procedure. You can pay the remaining $350 with tax-free dollars from your HSA.
If you contribute no more dollars or spend nothing further on medical expenses, you'll start the next year with $1,350 in your HSA. You will be allowed to contribute another $3,000 or $5,950, further building up your available balance if you wish.
Why HSAs aren't for everyone
HSAs are not for everyone because there are rules established by the Federal government that must be followed. If you have a good traditional health insurance plan, with excellent coverage, low co-pays, small deductibles, and up to 100% coverage for most common tests and procedures, you'll usually be prohibited from having an HSA. Since you are responsible for few out-of-pocket medical expenses, there is really no need for an HSA.
To be eligible to open an HSA, you need to have an HDHP. These are HSA-qualified health insurance plans, often costing less than classic programs. Similar to the tax rules for an IRA, you can contribute to your HSA up to April 15 of one year and apply it to your tax-free deposits of the prior year.
If you are employed by a company that offers one or two traditional health insurance plans, you'll probably not be a candidate for an HSA, nor should you need one. A good health insurance plan that requires reasonable co-pays, reimburses most diagnostic procedures, and covers most larger medical necessities (surgery, hospital stays, etc.) negates the necessity for an additional source of funds.
Should you work for a company that offers a cafeteria plan, allowing you to more or less "mix and match" health insurance coverages and companies, you might decide that an HDHP and an HSA is the most cost effective option.
While not for everyone, HSAs can be economic lifesavers, allowing you to use tax-free dollars to fill dangerous gaps in health insurance coverage.
How HSAs differ From flexible savings accounts (FSAs)
Don't confuse HSAs with FSAs (Flexible Savings Accounts). FSAs come in a few flavors for different purposes in addition to Health Care FSAs. Understand two primary features of FSAs that make them quite different from HSAs.
Plan years
Balances in FSAs usually MUST be used during a "plan year," which typically corresponds to a normal calendar year. Monies not spent by December 31 will be forfeited, unlike HSA balances which can be carried forward.
Qualified withdrawals
Withdrawals and expenses paid from FSAs must be "qualified". Expenses defined as qualified can also vary from company health plan to company health plan. You'll enjoy similar tax benefits as with HSAs, but there are some restrictions regarding those expenses that allow you to keep your tax-free status with FSAs.
Take control
Saving money and controlling health insurance costs are critical to keeping your personal budget balanced and affordable. A properly funded and managed health savings account can help you achieve the goal of good health care protection and a successful budget.
