By William Stuart, Product Specialist, Harvard Pilgrim Health Care

Health Savings Accounts (HSAs) represent the next revolution in tax-free investing. More than six million Americans have established HSAs and are enjoying the tax savings. That is a much higher rate of consumer participation than 401(k) plans enjoyed during a comparable point in their history, and projections show HSAs gaining in popularly as more people see the financial benefits of combining health care with a flexible financial vehicle that allows individuals to save on health care premiums and pay out-of-pocket expenses with pre-tax funds.

An HSA is a savings account that individuals can establish if they enroll in a specific qualified High Deductible Health Plan (HDHP) and meet eligibility requirements set by the Internal Revenue Service. Establishing an HSA allows an individual to:

• Save money on a pre-tax basis (similar to a 401(k) or traditional IRA) – up to $6,450 in 2007, up to $6,700 in 2008 and more in future years
• Earn a tax-free return on balances within the account (similar to a 401(k) or IRA)
• Distribute money tax-free for eligible health-related expenses
• Control and manage HSA savings like any other financial asset

Why the popularity of HSAs?

Why have millions of Americans established HSAs already? The answers may be as diverse as the individual HSA owners, but several factors influence many early adopters:

• HSA owners reduce taxable income when they contribute to their HSAs
• HSAs are triple tax-free accounts – pre-tax contributions, tax-free growth of account balances and tax-free distributions (if distributions are for eligible health-related expenses)
• HSA owners can use their HSA as tax-free savings or pre-tax spending accounts
• HSAs are financial assets that the owner controls and manages
• HSAs are portable (not tied to an employer) and do not have a “use it or lose it” provision like some other health reimbursement accounts
• Certain business owners who cannot participate in other tax-advantaged accounts (like Flexible Spending Accounts) can establish and contribute to their own HSAs
• HSA owners can save money on the underlying health plan premium

How do HSAs work?

An HSA is an individual account trust or custodial account held by a bank, brokerage firm, mutual fund company or insurer, similar to an IRA.

A typical HSA works like this:

• Individuals establish an HSA with an HSA custodian, either through their employer or on their own.
• HSA owners contribute to their accounts either through pre-tax payroll contributions if their employer allows them or with personal funds. (The employer – and, in fact, anyone else – can make contributions to an employee's HSA, too.)
• As individuals incur eligible expenses, they pay them with their HSA debit card, HSA checkbook or with personal funds.
• HSA owners can review account activity via monthly statements, by phone or online.
• At the end of the year, special tax forms reporting HSA contributions and distributions are created for personal income tax filing.

There are rules around eligibility for HSAs, allowable tax-free distributions and contribution limits that individuals must understand before taking full advantage of an HSA.

What is a High Deductible Health Plan?

The federal government requires that any individual who establishes an HSA be covered by a qualified High Deductible Health Plan (HDHP) and only an HDHP. (There are several other eligibility requirements as well.)

Individuals who purchase automobile insurance or homeowner's insurance understand that they can reduce their premiums by increasing their deductibles. When they increase the deductible from, say, $500 to $1,000, they in effect exchange a lower premium for the risk that if they actually file a claim, they'll have to pay more of their personal funds before insurance begins to pay for eligible services. A High Deductible Health Plan works on the same principle. Individuals pay a lower premium for health coverage but must pay for more services out-of-pocket before the health insurance begins to pay for services.

Here are the defining characteristics of an HDHP:

• Minimum In-Network Deductible:
• Individual contract: $1,100 in 2007 and 2008
• Family contract: $2,200 in 2007 and 2008
• Maximum In-Network Out-of-Pocket:
• Individual contract: $5, 500 in 2007 and $5,600 in 2008
• Family contract: $11,000 in 2007 and $11,200 in 2008
• All services are subject to deductible (though health plans are allowed to offer certain select preventive services at a higher level of coverage, as HPHC does)

Under the HDHP/HSA program, participating individuals can save for qualified medical expenses with a combination of health plan premium savings and funds channeled through the tax-free HSA, thus reducing the strain on their family budgets. In years when expenses are low, individuals build their HSA accounts so that they can cover their expenses tax-free in those years when they incur higher deductible expenses.

What's the downside to an HSA?

Some critics contend that HSA are for “the healthy, the wealthy and the wise.” Their concern is that program works best for individuals who are healthy and have lower deductible costs, wealthy enough to make large HSA contributions to take advantage of the tax benefits and wise enough to manage their accounts prudently. Individuals need to look at their personal health and financial situations to determine whether HDHP coverage and an HSA are right for them.

The bottom line

High Deductible Health Plans and Health Savings Accounts are having an impact in the health care and financial markets. Individuals who want to take more control of their health care and their finances are attracted to this opportunity to enjoy immediate tax savings, create long-term savings or simply to realize premium savings. HSA owners retain the flexibility to manage their HSA to meet any of these objectives – and to change their approaches at any time.

We expect HSAs to grow in popularity as employers and employees struggle to keep up with double-digit increases in health care premiums. HDHPs and HSA provide individuals with the tools and resources to manage their health care in a way that maximizes both their physical and financial health. The revolution is here – the only question is how quickly you move to take greater control of your health care and begin to build the financial assets to cover your future health care expenses.

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September 26th , 7:30am-9:30am

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