How Health Savings Accounts Work

A month ago, Jenny Thomas checked into her local hospital to deliver her first child. Unanticipated complications necessitated an emergency surgery. Fortunately both she and the baby were fine. But if it hadn't been for her family's health savings account (HSA), she could have ended up owing the hospital tens of thousands of dollars.

"An HSA is smart savings plan that you use for unanticipated medical expenses," says Kurt Stammberger, vice president of marketing for Vimo, a company that provides comparison shopping information on health insurance plans, products and doctors. "Usually, money that save in the plan comes out of your paycheck before payroll taxes are computed, so you maximize your savings rate. Furthermore, any income that the HAS plan itself generates (such as from interest or investment appreciation) is also tax free, so it grows fast. Some employers even contribute extra matching cash to the plan to encourage you to save."

In most parts of the country, to be eligible for an HSA you also need to hold a High-Deductible Health Plan (HDHP). An HDHP is a plan where the deductible - that is the amount that you pay out of pocket, before the insurance "kicks in" is somewhat higher that what you might have seen before: usually in the neighborhood of $2,000 to $3,000. The big idea behind the HSA/HDHP combo is that the premiums on the high-deductible plan are so much lower that even though you pay the first couple of thousand "out-of-pocket" - actually out of your HSA - you save money in the long run over a traditional plan.

"Hundreds of banks, credit unions and insurance companies offer HSAs, and it's easy to sign up," Stammberger says. Once you're enrolled, you can use the money in the account for almost any approved medical, dental, vision or disability health care or expense.

HSAs differ from one another mostly in the ways they grow. Some HSAs grow like traditional savings accounts, with interest compounding daily. Other HSAs let you be more aggressive and pick money market funds, mutual funds or other investment vehicles so that you can maximize the growth of the account. It's up to you, and you should make sure you understand the investment choices available to you before you select your HSA institution.

After you have opened an HSA, managing the account is pretty easy. You set up automatic deductions from your paycheck, usually totaling an annual amount less than your HDHP deductible. You then invest your accumulating HSA funds in interest-bearing accounts, stocks, bonds and/or mutual funds, depending on the choices available to you at your HSA institution. Returns on these investments are tax-free, so they compound fast! If, in some year, you don't use the cash, it automatically gets carried over to the next year. So in this way HSA's are different from "Flexible Spending Accounts" which typically follow a "use it or lose it" approach.

To learn more about health savings accounts, visit www.vimo.com.

Copyright © 2006, ARA Content