It appears that most Americans who can qualify for Health Savings Accounts (HSAs) are not taking advantage of them. There may be several reasons for this trend. Lack of knowledge about HSAs or that a HSA is even an option is probably the prime reason. As you hear me say again and again, for some reason insurance just is not as sexy as investments. Luckily, HSAs do involve investments so this article might be sexier that my other posts. This post will provide a basic overview of HSAs and some miscellaneous ramblings about why I like HSAs.HSAs are composed of two elements, one being a savings account and the other being a high deductible insurance policy. The savings account component is simple enough to understand, as it is really not much different than other brokerage accounts. Once someone finds a high deductible insurance policy, all they have to do is search around for a HSA custodian. The custodian then accepts investments, allows the account owner to select the investments, and liquidates the investments at the direction of the account owner. Many banks and insurance companies offer HSA savings accounts; however, a number of the larger custodians (such as Schwab) have yet to enter the HSA market. A few of the primary factors to consider in selecting a custodian are the types of investments that the custodian allows, what fees/expenses the custodian charges, and whether the custodian provides a checkbook or credit card for the account holder to use to pay his or her medical expenses (of course, another factor to consider is the stability and reputation of the custodian). Currently most HSA custodians’ only allow limited investment choices and the fees are a little high (as compared to the really low costs for other investment brokerage accounts). This should change when more of the larger brokerage institutions enter the HSA market (and since HSAs are freely transferable, investors should be able to move their HSAs over relatively easy when the time comes).

The high deductible insurance policy is also relatively straightforward (technically, it is referred to as a “high deductible health plan ” or a “HDHP “). Essentially the high deductible insurance policy is the same as a regular insurance policy, with the exception that coverage does not kick in until the insured satisfies the high deductible payment. Federal law sets the minimum deductible at $1,050 for single individuals and $2,100 for families (these are the 2006 figures). Federal law also sets the maximum annual out of pocket expenses at $5,250 for single individuals and $10,500 for families. In general, the minimum deductible spelled out in the insurance plan is the maximum amount that can be contributed to the HSA savings account (the actual numbers do vary slightly). The maximum amount that can be contributed to the HSA savings account is $2,700 for single individuals and $5,450 for families (again, these are the 2006 figures).

So you might be saying, what is the big deal? The big deal relates to the tax treatment of HSAs. Taxpayers are entitled to deduct an amount equal to the funds placed in the HSA savings account on their taxes each year. This deduction is an above the line deduction, so, it may reduce a taxpayers income (adjusted gross income) enough to allow taxpayers to qualify for other tax benefits. Moreover, the funds in the HSA savings account grow tax-free and they can be withdrawn tax-free to pay for “qualified medical expenses. ” Thus, HSAs are highly tax efficient. HSAs are an especially attractive option for younger taxpayers who can allow the HSA to grow tax-free for many years. Assuming that the HSA savings account investments do well and the younger taxpayer does not withdraw the funds, the HSA could very well offset most of the taxpayers future medical costs (or at a minimum, keep up with the rising costs of health care).

The big deal for HSAs also includes the ability to select your own investments and have your own account, rather than relying on health insurance companies to charge premiums to current policy holders to pay your benefits. This feature is especially important given the current trends in our society. We know that our workforce is to decline as more Baby Boomers retire and pass away. We also know that health care costs are going to continue to increase at a rate higher than most other services. Thus, in the future there will be fewer customers for the insurance company to collect from to pay your bills and your bills will be substantially more costly than they are today. We all know what that means: traditional health insurance coverage is going to be even more costly and even more cost prohibitive in the future. Setting aside funds in your own HSA today makes a lot of sense.

Another part of the big deal with HSAs involves your being able to select what expenses you want the HSA to cover. As mentioned above, distributions from HSA savings accounts are tax-free if they are for “qualified medical expenses. ” The law spells out what is and what is not a “qualified ” expense. As you probably guessed, elective surgery and routine care are not “qualified. ” However, there are other expenses that are “qualified, ” such as prescription drugs and even long-term care premiums (premiums for most other types of insurance are not “qualified “). By being able to select what expenses to pay from the HSA, the account owner can in effect decide how much he or she would like to remain tax-free in the account for future use and it may encourage the account owner to seek out cost-effective treatment (i.e., asking the doctor to give you a break on the bill). Thus, HSAs could force doctors and hospitals to lower their costs in order to continue to attract new customers (this is just my personal opinion, but I do believe that health care costs are so high not because of our legal system, but because doctors and health care consumers have no incentive to provide or seek out cost-effective services, because both parties know or hope that insurance companies will foot the bill. I know that some of you out there may disagree with this, so please do feel free to set the record straight in the comments).

Okay so who qualifies for HSAs? The short answer is that basically everyone who does not work for an employer who offers traditional health insurance, who is not claimed as a dependent on someone else’s tax return, and who participates in a high deductible insurance policy is eligible to participate in HSAs. Both employees and/or employers can make contributions to HSAs; however, one cannot continue to contribute when the insured begins receiving Medicare.

There really is so much more about HSAs; however, this post is already getting a bit long. To sum up, if you are not currently covered by a traditional health insurance policy you should check out HSAs.

By: Robert Klein
Klein & Klien Insurance Consultants
1811 Santa Fe
Houston, Texas 77703