What is a Health Savings Account or HSA? The recently passed Medicare Modernization Act of 2003 contains important provisions that create private, tax-free accounts individuals can use to save for their health costs.

An HSA works like an IRA (Individual Retirement Account), except that money is used to pay health care costs incurred by individuals, their spouse or dependents. Participants must enroll in a high deductible insurance plan specifically approved for use with an HSA. Then, a tax deductible savings account is opened to cover current and future medical expenses. The HSA coverage must be your only health insurance. The money deposited, as well as the earnings, is tax-deferred. The money can then be withdrawn to cover qualified medical expenses tax-free. Unused balances roll over from year to year.

What is a high deductible insurance plan or HDHP (High Deductible Health Plan)? For 2006, a high deductible insurance plan is a plan with a minimum deductible of $1,050 for self-only coverage and $2,100 for family coverage. The maximum out-of-pocket expenses for allowed costs must be no more than $5,250 for self-only coverage and no more than $10,500 for family.

Participants can make tax deductible deposits to the accounts. Up to 100% of the health plan deductible may be saved annually (2006 limit is the lesser of deductible, or $2,700 for single coverage, and $5,450 for family coverage. Amount increased is based on the Consumer Price Index.) Individuals age 55-65 can make additional tax-free catch-up contributions of up to $700 in 2006, gradually increasing to $1,000 by 2009. Note that the deduction for contributions by individuals is an “above-the-line” deduction, meaning that the contributions are deductible whether or not the taxpayer itemizes other deductions. Deductible contributions can be made to the plan up until the due date of the return, generally April 15.

Employers can deduct contributions to HSAs (within the limits explained above) for employees who are eligible. HSAs can be offered under an employer’s cafeteria plan. An employee who is an eligible individual will be able to exclude amounts contributed by his employer to his HSA, and these amounts won’t be subject to FICA, FUTA, or income tax withholding.

Distributions used to pay qualified medical expenses not covered by health insurance are completely tax-free. Distributions can be used to pay for retiree health insurance, Medicare expenses, longterm care services and insurance, prescription drugs, surgery and other medical treatments and amounts not used to pay qualified medical expenses can be carried over from year-to-year, even if the HSA is provided under a cafeteria plan.

Money can be withdrawn from an HSA for purposes other than medical expenses after payment of income tax plus a 10% penalty. The 10% penalty will not apply in the case of distributions made after age 65 or for distributions made due to death or disability.

HSAs are portable when an employee changes employers. Contributions and earnings belong to the account holder, not an employer.

There are no income-related eligibility requirements. Assets can be passed on to the surviving spouse. Otherwise, the assets will be included in the deceased beneficiary’s estate. Employers are required to report amounts contributed to an HSA on the employee’s Form W-2. Nondiscrimination rules apply to employer contributions to HSAs. Employers who make a contribution to an HSA for an employee during a year generally are required to make available comparable contributions to the HSAs of all comparable participating employees during the same year. Dozens of companies currently offer Health Savings Accounts and High Deductible Health Plans. You can obtain a quote from several top providers by entering your state of residence above and clicking on "Quote". A list of some companies currently offering HSA's can be found here.