Health Savings Account (HSA) Overview

General Characteristics of HSAs

Health Savings Accounts (HSAs) were introduced in 2004 and have quickly become a popular method for financing health care. For most people, HSAs provide a better way to minimize total health care expenses.

This overview is meant for quick and convenient reference. If you want to study HSAs in depth, you'll find more detailed information at the US Treasury website.

Two Components to HSA Package

What is generally called an "HSA" is actually two parts, a financial account (the HSA) and a health insurance policy:

Health Savings Account (HSA) The tax-advantaged Health Savings Account (HSA) is a type of checking account with a bank or other financial institution. Funds are withdrawn by writing checks or by using a debit card.
High Deductible Health Plan
You can't establish an HSA, unless you're enrolled in an HSA-compatible health insurance plan with certain benefit characteristics, including a high annual deductible. However, you can enroll in one of these high-deductible plans without having to set up an HSA.

Tax Advantages

Your deposits to a Health Savings Account (HSA) reduce your taxable income, and withdraws are never taxed, as long as these funds are used to pay qualified expenses, which are defined by the IRS. In other words, HSAs allow you to fund health care expenses with pre-tax money.

Unused HSA funds are yours to keep, and can remain in the account, without tax consequence, for many years. You can continue, until age 65, to make tax-advantaged annual HSA deposits up to the yearly funding limit.

HSA Funding Limits

For 2008, annual HSA contributions are limited to $2900 for an individual or to $5800 for a family.

Prior to 2007, HSA contributions could not be greater than your HSA-compatible health insurance plan deductible, but this is no longer true. For example, if you're a single person with a $1500 HSA plan deductible, you can still contribute, for 2008, the maximum $2900 to your account.

HSA holders age 55 and older can make, for 2008, additional annual contributions of $900. In 2009, this additional contribution increases to $1000.

HSA Tradeoffs

In our view, most people are better off with HSAs. But there's no free lunch.

When you enroll in an HSA-compatible health plan, you may be giving up some generous benefits. You'll likely have a higher deductible, and you won't have convenient co-pay benefits for office visits and for prescriptions.

However, for the majority of consumers, these compromises are outweighed by the following gains:

Your health insurance premium is reduced.
Your average annual rate of increase in health insurance premiums is reduced.
Your income taxes are reduced because of the deduction for HSA deposits.
Out-of-pocket health expenses are paid with pre-tax rather than after-tax money.
You've established a new savings source.
You'll probably be more prudent in purchasing health care services.

Changing How We Buy Health Care

A primary goal in the development of HSAs was to motivate greater consumer involvement in medical purchasing decisions. Most people tend to make wiser and more economical health care choices when they're spending your own money -- especially when that money would otherwise grow in a tax-advantaged account.

Being smarter about purchasing health care also means getting better cost information, which can be challenging, but it's getting simpler. The internet is beginning to provide some of the information (like doctor and hospital fee data) we need to be more knowledgeable consumers. This issue of "provider cost transparency" is a key element of the health insurance industry's growing Consumer Directed Health Care (CDHC) movement.

Retirement Savings

If you've established an HSA, you're not required to withdraw HSA funds to pay for each medical expense. You can make deposits each year, let the money accumulate and generate tax-advantaged investment income. Correspondingly, some people view their HSA as a pure retirement account, similar to an IRA or 401k.

On the other hand, financial planners recommend using HSA savings to fund un-reimbursed qualified health care expenses. But the money in your HSA is yours and you can manage it as you want.

For most people, the HSA functions both as a retirement account AND and as a tax-advantaged health care funding tool.

Freedom of Choice

Virtually all HSA-compatible high deductible health insurance plans are PPO-based products with expansive networks of physicians and hospitals. Under these plans, you don't have to choose a primary care physician and you don't need permission to visit a specialist.

How High a Deductible?

The higher your deductible, the lower your health insurance premium. Most people choose HSA-compatible plans with deductibles near the maximum contribution limits (for 2008) of $2900 for an individual and $5800 for a family.

As your HSA balance grows, you may be comfortable purchasing even higher deductibles and further reducing your premium expense. $5000 individual deductibles and $10,000 family deductibles are not uncommon.

Are HSAs Right for Everyone?

Not quite. HSAs may not be the best deal for people with major ongoing medical expenses, and people approaching age 65 are less likely to realize savings because they have fewer years to contribute to an HSA (though this is partially offset by the extra contributions allowed for persons age 55 and older).

However, in our view, the large majority of consumers are better off with HSAs.

If you're not sure whether an HSA is right for you, consider this general advice, gained from evaluating countless HSA scenarios: The financial upside of HSAs can be very meaningful, while the financial downside, if any, is usually quite limited.

So far, we haven't encountered a single HSA customer who has voluntarily changed back to traditional health insurance.

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