80. Save $1,000s+ per year Save money with a Health Savings Account (HSA)

Benefits Worth Evaluating

Inflation might be around 3% per year on average, but that's certainly not true for health insurance. In 2004, employer-sponsored health insurance premiums rose by 11.2%, the fourth straight year of double-digit increases, and this streak likely will be extended.

A benefit worth evaluating by employers and by individuals is a health savings account (HSA), which became available in 2004. In particular, a new IRS ruling clarifies the tax-saving opportunities for married couples.

To understand HSAs, you should think of them as a combination of (1) a high-deductible health insurance policy and (2) a tax-deductible savings and investment account, with some restrictions. Here's what you need to know to make good use of an HSA:

High deductibles

In order to have an HSA, you must have a health insurance policy with a deductible of at least $1,000 for individual coverage or $2,000 for families. That's higher than the deductibles for most non-HSA health policies.

A "stop-loss" provision must hold your out-of-pocket costs to no more than $5,100 in a given year (individual), or $10,200 for family coverage. This includes co-payments as well as your deductible. All of these numbers are indexed for inflation.

This type of coverage is widely available, but not to everyone, everywhere. In some states, for example, individuals and large groups can get HSA-conforming health insurance, but not companies with fewer than 50 employees.

The policies that meet HSA requirements are basically designed to provide catastrophic health insurance coverage. You pay for treatment for bumps and bruises out of your own pocket, but there's protection against large medical bills.

Benefit: High-deductible insurance is less expensive than low-deductible coverage, which covers less expensive procedures.

Example: John Jones is self-employed. Formerly, the health insurance he purchased for his family had a $1,000 deductible and cost $8,000 per year. John switched to a policy with a $5,000 deductible and cut his premiums to $3,200 per year.

Result: John will pay more of his smaller medical bills on his own, but he saves $4,800 per year in health insurance premiums. It is these savings that are often used to make contributions to the savings account part of an HSA.

Key: Today's lower premiums should translate into lower premiums year after year, compared with traditional health insurance policies. A 10% increase on $3,200 is only $320 per year, for example, while a 10% increase on a policy costing $8,000 per year would raise your outlays by $800.

The HSA payoff

Equipped with high-deductible health insurance that meets the above requirements, you are ready to set up an HSA.

How it works: Some insurers offer the insurance policy and the HSA that goes with it. You do not have to use the insurer's account, though. Other financial firms (banks, mutual fund companies) will provide an HSA if you have the requisite insurance policy. Contributions you make to this account are tax deductible. Alternatively, employers may contribute to employees' HSAs.

The contributions can be as great as the policy's deductible. For example, with a $1,000 deductible on your health insurance policy, you can put as much as $1,000 per year into an HSA.

Limit: In 2005, maximum HSA contributions are $2,650 for individual coverage, $5,250 for families. For 2006, the maximums will be adjusted for inflation.

In addition to your basic contribution, you can make "catch-up" contributions of up to $600 per year, if you are age 55 or older. That number will grow by $100 each year through 2009.

Deadline: As is the case with IRAs, you have until April 15 to make your final contributions to an HSA for the previous year.

Tax treatment: If contributions are made by an employer, the amount is deductible by the company and not counted in an employee's income.

Contributions by individuals are above-the-line deductions from adjusted gross income (AGI). Thus, they're deductible even for those who don't take itemized deductions.

Above-the-line deductions reduce your AGI, which can save you taxes elsewhere on your return.

HSA contributions can be invested in virtually any manner. Investment earnings inside an HSA are untaxed. Most HSAs are invested in interest-bearing accounts (now paying 2% to 4%) but the list of providers offering other investments is expanding. If you're willing to bear some risk in return for possibly higher long-term returns, mutual funds can be used.

Loophole: HSAs can be tapped for a wide variety of health-care expenses, including those usually not covered by health insurance, such as laser eye surgery, dental work, and cosmetic surgery needed because of injury, trauma, or disease.

Withdrawals for qualified medical expenses are tax free.

Benefits: HSAs allow you to pay medical bills with pretax dollars. There are no restrictions on your choice of doctors or hospitals. You can go anywhere with your HSA dollars. Some HSA insurance policies have a provider network, though, and it may cost less to spend HSA dollars in the network if discounts are offered.

Amounts not used for medical bills can remain in your HSA, rolling over from year to year. Earnings will continue to be untaxed.

Ultimately, if you are fortunate enough not to have to draw it down anytime soon, your HSA can be tapped years later, if, say, your health-care costs increase.

Age factors

To contribute to an HSA, you must be less than 65 years old.

Trap: Before age 65, withdrawals for nonmedical expenses are subject to a 10% penalty as well as income tax.

After age 65, withdrawals for unqualified expenses are taxed but not penalized.

In this regard, HSAs act like another IRA. If you're healthy, an HSA becomes a supplemental retirement fund.

Even after you reach 65 and become Medicare-eligible, you can tap your HSA to pay health-care expenses tax free. However, HSA money can't be used to pay for "Medigap" insurance premiums.

Family-friendly IRS ruling

Recently, the IRS issued Revenue Ruling 2005-25, which clarified some HSA questions.

Issue: You can't have an HSA if you're covered under another health plan. If one spouse has family coverage that extends to the other spouse, neither spouse can have an HSA.

What happens, though, if one spouse is excluded from family coverage?

Ruling: The spouse without coverage can have an HSA and make the allowable tax-deductible contribution. It makes no difference how the family's children are covered.

Example: Jane Smith is employed by a company that has a health plan, but the coverage is low-deductible insurance that does not qualify for an HSA.

Jane's husband, Mark, is not covered by Jane's plan, so he takes out a high-deductible policy that conforms to the HSA rules.

Result: Mark can make deductible HSA contributions up to the allowable limits. This will be true whether the couple's children are covered by Jane's plan, Mark's policy, or divided between the two.

Another new ruling: Inheritance. One spouse may bequeath an HSA to the other spouse. An HSA inherited from a spouse retains its tax advantages.

(An HSA inherited from a non-spouse becomes a taxable account.)

This ruling gives married couples more flexibility in determining how they want to obtain health insurance.

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