Health savings accounts: Is an HSA right for you?

Health savings accounts are like personal savings accounts, but the money in them can only be used for health care expenses. You — not your employer or insurance company — own and control the money in your health savings account. The money you deposit is not taxed, and you can invest it in stocks, bonds and mutual funds. To be eligible to open a health savings account, you must have a special type of health insurance called a high-deductible plan. Sometimes referred to as "catastrophic coverage," high-deductible plans act like a safety net if you need extensive medical care.

Why were health savings accounts created?

Health savings accounts were established in 2003 as part of a larger trend known as consumer-directed or consumer-driven health care. Health savings accounts have been promoted by companies and the government as a way to help control health care costs. The theory is that consumers will spend their health care dollars more wisely if they're spending their own money. In addition, doctors and other health care providers will have an incentive to lower their rates because they're competing for consumers' business.

Is a health savings account right for me?

Like any health care option, health savings accounts have advantages and disadvantages. When considering a health savings account (HSA), think about your anticipated health care expenses, your financial situation and how much control you want over your health care spending. If you're generally healthy and want to save for future health care expenses, an HSA may be an attractive choice. On the other hand, if you anticipate needing expensive medical care in the next year and would find it hard to meet a high deductible, an HSA might not be your best option.

Sources: American Medical Association, 2010; Kaiser Family Foundation, 2010; New England Journal of Medicine, 2006; U.S. Department of the Treasury, 2010.

Who can set up a health savings account?

You can start an HSA on your own through a bank or other financial institution, or your employer may offer an HSA option. To qualify for an HSA, you must be under age 65 and carry a high-deductible health insurance plan. If you have a spouse who uses your insurance as secondary coverage, he or she also must be enrolled in a high-deductible plan. This high-deductible health insurance plan must be your only health insurance coverage — you can't be covered by other health insurance. However, having dental, vision, disability and long term care insurance doesn't disqualify you from having an HSA.

How does a high-deductible insurance plan work?

As its name implies, it's a health insurance plan that has a high deductible (the amount of medical expenses you must pay annually before coverage kicks in). The premiums (the regular fee you pay to obtain coverage) for a high-deductible insurance plan are typically lower than premiums for traditional insurance plans.

However, a high-deductible plan doesn't start paying until after you've spent a thousand dollars or more of your own money on health care expenses. (This unpaid portion of expenses is known as a deductible.) You can use your HSA to pay deductible expenses, copays, coinsurance payments and other noncovered health care expenses.

Not all high-deductible insurance plans work the same. For instance, some cover preventive services, such as mammograms, before the deductible is met. Review the plan's coverage details carefully, including the out-of-pocket maximum — the limit on how much you would have to pay out of pocket for medical expenses in a year.

How much money can I deposit annually into a health savings account?

The Internal Revenue Service decides how much you can contribute each year. A good source of the most up-to-date information on those amounts is the Department of the Treasury's website. In recent years, the contribution limits have been about $3,000 for individuals and about $6,000 for family coverage. The limits are indexed for inflation and adjusted each year. Unspent money in your HSA can be rolled over each year.

Can I use pretax money to fund a health savings account?

If your employer offers a high-deductible insurance plan, you may be able to deposit money into an HSA on a pretax basis. If you open an HSA on your own, you can deduct your deposits when you file your income taxes.

Can my employer contribute to my health savings account, too?

Yes, your employer can contribute to your HSA. But the total of your employer's contribution plus your contribution still must be within the contribution limits.

Are health savings accounts similar to flexible spending accounts?

Yes, but there are a couple of key differences. First, with an HSA you can keep (roll over) any unspent money each year. You can't do that with a flexible spending account. Second, money put into an HSA is yours and can be taken with you if you switch jobs or retire. You can't take money from an employer-sponsored flexible spending account with you if you quit or change jobs. Also, it's important to know that in most cases you can't have both an HSA and a flexible spending account.

How do I find information about medical costs and quality so I can make informed choices?

It can be challenging. Right now it's difficult to get reliable information regarding the cost and quality of treatment options, doctors and hospitals. Your employer or health plan may offer some Web-based tools, as well as access to someone by phone who can give you some basic information. The hope is that as health savings accounts and other consumer-directed health care options become more widespread, the access to information about cost and quality will expand.

Can I withdraw money from a health savings account for nonmedical expenses?

Yes, but if you withdraw funds for nonmedical expenses before you turn 65, you have to pay taxes on the money and a 10 percent penalty. If you take money out after you turn 65, you don't have a penalty, but you must still pay taxes on the money.