Meet The HSA

A police car with shot out windows is seen May 2, 2010 in Richmond, Va. after a shootout between an armed suspect and police that was caught on tape by CBS cameras.
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The Health Savings Account (HSA) actually is being called the most significant savings opportunity for individuals since the IRA and the 401(k). So it's probably time for you to learn more about it, and financial adviser Ray Martin drops by The Saturday Early Show to help.

As open enrollment begins, there are going to be more letters in your benefit "alphabet soup."

HSAs were created in January, and more and more people are finding that they're an excellent way to cut insurance bills while saving pre-tax dollars for health costs.

But what are HSAs? How do they work? Who should have one? How do you get one?

An HSA is a savings vehicle that allows you to set aside tax-free money. That money must be used for health-related costs.

Here's the catch: in order to qualify for an HSA, you must be enrolled in a high-deductible health plan (also known as an HDHP). That means that your insurance deductible must be at least $1,000 for singles and $2,000 for couples or families. You can then invest up to the amount of your deductible in your HSA (capped at $2,600 for singles and $5,150 for families).

Unlike a flexible spending account, you don't have to use all of the money in your account each year. It can remain in the account and grow.

You can use the money for non-health purposes, but you'll have to pay for it. Before age 65, you'll pay income taxes on the money and a 10 percent penalty fee. After age 65, you'll only have to pay taxes on the funds you withdraw.

Qualifying HSA expenses are broad, even including items such as braces for your kids and contact lenses. You cannot use the money for cosmetic surgery. A full list of qualifying expenses can be found on the IRS Web site.

Who should get an HSA?

The real question is: Who should have a high-deductible health plan (HDHP)? Obviously, enrolling in an HSA is a no-brainer for anyone who already has such a plan. A high-deductible plan is an affordable option for anyone who is self employed and forking over a lot of money for insurance. The plan is also a smart move for anyone who is not employed and is without insurance.

But what about the average employee who is working for a medium- or large-sized company and already has health insurance? Should everyone consider switching to a high-deductible plan?

A high-deductible plan will cover preventive care and will cover you if high-cost disaster strikes. You have to decide: Are you willing to take the risk of paying for semi-expensive items that may cost as much as $5,000 out of your own pocket in return for significantly lower premiums and tax savings?

If you are young and healthy, chances are you don't do much more than visit the doctor for an annual exam. If you're like most people, you'll incur most of your lifetime expenditures for medical care in the last third of your life. So, it would make sense for you to consider a high-deductible plan and the accompanying HSA, because the chance of you incurring a significant medical cost is low. You would be able to save the money you weren't spending on insurance premiums tax free, and it could grow into a nice chunk of money over the years.

Martin himself says that if he had an HSA and contributed the $2,000 per year to it over 15 years, and earned 3 percent interest, his HSA could now be worth about $37,000. Once he had a chunk of change like that in an HSA, he would be more likely to continue to use a High-Deductible Health Plan (HDHP) and save into the HSA going forward.

This illustrates one of the things Martin likes about this concept: If this all plays out as planned, an HSA allows an individual or family to save into a tax-free account and withdraw the funds in the future, when they are older and when these savings are most needed for medical expenses.

But remember: it's your responsibility to put money away in the HSA. It is not automatically deducted from your paycheck. So you have to be a committed saver. This is a-little-all-the-time savings strategy and to accumulate a meaningful amount in an HSA to use in the future, you must make the contributions every year.

An HSA becomes an even better deal when employers agree to contribute money to your account. When you choose a high-deductible plan over regular health insurance, you save your employer a lot of money. Some companies will agree to put the money they are saving into your HSA. This sweetens the deal significantly, and if your company offers this option, you should think seriously about enrolling in an HSA.

Most people won't choose to enroll in an HSA. But you will begin receiving information on it from your employer, so you should know what it is.

Martin believes that high-deductible plans are going to become increasingly common as employers and the insurance industry figure out that they can save money by encouraging employees to use them.

Finally, because HSAs are so new, they will continue to evolve and may make sense for more people down the road.

Here are some things Ray Martin likes about HSAs:

  1. Triple Tax-Free Savings: HSA contributions are an above-the-line deduction from income, and therefore reduce your income for federal, state and employment tax purposes. That means that HSAs allow for tax-exempt, tax deferred earnings on the savings in the HSA, and HSA withdrawals are tax-free when used for qualified medical expenses.
  2. No "use-it-or-lose it" feature. An HSA is owned by the individual, and all amounts in an HSA are fully vested; unspent amounts remain in the account and grow with interest.
  3. Encourages better medical services purchasing: When using their HSA savings to pay for medical expenses, consumers are more likely to compare the cost of medical services and verify billing amounts.
  4. Save for tomorrow's medical expenses with today's dollars: HSAs allow individuals to do so when they are more likely to be able to save (young with more discretionary income).
  5. Increases number of affordable health insurance options: Many people don't have health insurance because they can't afford it. These individuals will now have more lower-cost HDHP options to choose from and can now use an HSA to save and pay for expenses that are under the deductible.
  6. HSA withdrawals can be used to pay for other medical coverage such as long-term care insurance premiums and Medicare Part B premiums with tax-free withdrawals.
One of Martin's concerns about the HSA is the "as long as" factor: "As long as your employer still offers to pay a set dollar amount towards your health insurance or other benefits, including the option to receive some of this in cash, and you enroll in the high-deductible health plan, open an HSA and your employer contributes the savings into the HSA, then HSAs will be a good deal for employees in this situation."

But Martin is skeptical about this happening over the long term ,as employers are under tremendous financial pressure to cut their costs of benefits. Allowing employees to opt for a high-deductible health plan and paying them the savings in cash does not, by itself, reduce an employer's costs for health insurance.

It's likely that employers will first offer high-deductible health plans and HSAs to their employees and see what the sign-up rate is. If it's a measurable number of employees, then, in later years, the employers probably will announce that they are cutting back what they pay towards health insurance costs for employees. So, if you want to keep funding your HSA at the same amount, you'll need to make up the difference out of your own income.

But this is not a reason to not sign up for an high-deductible health plan and HSA, because the trend of employers cutting back their contributions towards health insurance is well established, and it is safe to assume that this trend will continue for most employees.

Another concern of Martin's: The effect of adverse risk selection on health insurance overall.

Martin says that people who are low users of medical services (more likely to be young and very healthy) are more likely to sign up for HDHPs and those who are good savers (above-average income) are more likely to sign up for HSAs.

What will be the effect on those who stay enrolled in low-deductible health options? The logical answer is that the cost of insurance will soar (because those who use health services the most will be those who are in low-deductible health plans) and low-deductible health insurance plan premiums will rise so high, that individuals will be forced to convert to high-deductible health plans.

For more information about Health Savings Accounts, go to The HSA Insider.