Now anyone can set up a Health Savings Account, where contributions are tax-deductible and withdrawals are tax-free. If you have the cash and good health, they're just the ticket.

 By Jeff Schnepper

Tax-deductible going in, no tax when you take it out. You can’t get a much better deal on any savings account than that.

I’m talking about the Health Savings Accounts (HSAs) that were created last year as part of the Medicare Act of 2003.

The concept is easy. Congress wants to give you the opportunity to take charge of your own health costs. So, if you buy their special ticket, you’ll be able to set up a magical account. You’ll be able to put money into that account and deduct the contribution. You pay no taxes while the money is held in the account. And, if you take the dollars out for the right reasons, there’s no tax ever.

Technically, it’s a bit more complicated. Let’s start with the special ticket.

The nuts and bolts
To open a Health Savings Account, you have to buy a high-deductible health plan. It must be your only health plan. (There are some exceptions, such as workers’ compensation or coverage under an auto policy.)

A high-deductible health plan is one with an annual deductible of not less than $1,000 for individual coverage and not less than $2,000 for family coverage. That means you pay for the routine medical visits, tests, glasses and the like. Remember, the bigger the deductible, the smaller the premium you have to pay.

In addition, the sum of the annual deductible and other out-of-pocket expenses you can be required to pay under the plan can’t exceed $5,000 for individual coverage and $10,000 for family coverage.

Can your employer offer a high-deductible health plan? Sure. In fact, many supporters of the concept expect large employers to offer the option before long.

If you’ve got this special ticket, you can now set up your own Health Savings Account.

The source of the money you put into the account? You can use the premiums you saved by switching to a high-deductible health plan.

Now, take your break
Technically, the HSA is a trust. You can now contribute into that trust and take a tax deduction for the lesser of:

• The annual deductible for your high-deductible health insurance
  

• $2,700 ($5,550 with family coverage)

Up to the limits, the higher the deductible, the lower your premiums and the more you can put into the HSA pot.

If you’re age 55 or older, you can make additional deductible contributions. For 2004, it’s an extra $500. It increases $100 each year until 2009, when the bonus reaches $1,000.

And you can pretty much invest the money any way you want, like a Roth Individual Retirement Account.

You can dip into this pot at any time. Any dollars used for medical expenses come out tax-free. You can use the HSA for routine doctor visits, lab tests, eyeglasses, dental care or cosmetic surgery. Anything left over at the end of the year rolls back into the pot. So, if you’re young and healthy, you could build up a nice pot of cash in case of catastrophic problem years later.

There’s one important difference between this account and health care accounts your employer might set up. In the latter case, you have to use your contributions or lose them. In the case of an HSA, any money left over at the end of the year can be used in the next.

What you can’t do with it
You cannot use your HSA to buy health insurance. But you can spend the money on payments for long-term care insurance. You can also use the money for temporary health insurance while you’re unemployed and collecting unemployment or for COBRA continuation insurance when you lose an employer's health coverage.

If you withdraw the money for non-medical purposes, you pay the usual income tax, plus a 10% penalty, on the nonqualified amount.

Similar accounts, the Archer Medical Savings Accounts, have been around for a few years. But the Archer MSAs were limited basically to owners of small businesses and the self-employed or their spouses. The law permitted as many as 700,000 of the accounts, but only about 80,000 were ever opened. They were also temporary and scheduled to terminate after a trial period that ended this year. That really didn’t encourage insurance companies to develop the appropriate policies on a mass basis.

In fact, you can’t open an Archer account anymore.

The new Health Savings Accounts are designed to be permanent and can be used by anybody.

HSAs can be offered to employees as part of a cafeteria plan offered by employers. Contributions can be made by both employers and employees. Whoever puts the dollars in gets the deduction.

Making the numbers work
Here’s how the numbers might work, according to Scott Krienke, a vice president with Fortis Insurance, which has been a big supporter of the concept. A couple in Ohio, both 38, with two children could buy a health policy with a $5,000 deductible for $250 a month, or $3,000 a year. A plan with a $500 deductible would cost $600 a month, or $7,200 a year.

With the $3,000 plan, the family saves $4,200 in premiums. That money, in turn, can be used to fund a HSA, and contributions to the account will be fully deductible.

Now, you’re in charge with two big advantages.

• First you’ve got the tax savings. In the 35% bracket, that’s an additional $1,470 in your pocket.
  

• More importantly, you now have control over your own medical expenditures. For a $10 co-payment, it was easy to visit the doctor. But, now it’s your money that’s being spent, and you can choose whatever doctor or medical service you want whenever you want and at whatever fee you can negotiate. In theory, that should help put a brake on runaway health costs.

Critics argue that most people don’t have time to shop for medical fees, and that the wealthy will opt out of traditional plans for these accounts. That will push premiums on traditional plans even higher, they say.

Now a word on the downsides
While anyone can open one of these accounts, they may not be for everyone.

• Families with young children may find that traditional managed-care accounts work better for them. They demand a lot of services and need to conserve cash.
  

• The cash outlay to take advantage of the accounts is big. A lot of people may not be willing to commit themselves to big deductibles, and they must plan their health-care spending more carefully, says Greg Scandlen of Galen Institute, another big supporter of the plans.

Still, if you’re young, healthy, or wealthy, this may be a deal you don’t want to pass up. I know of no other vehicle where you get a deduction with a deposit, and no tax with a withdrawal.