How Do Health Savings Accounts Work?

What is a Health Savings Account?

A heath savings account, or HSA for short, is a type of savings account designed to help U.S. taxpayers save money toward future medical expenses. To be eligible for an HSA, one must be enrolled in a high-deductible health plan, an insurance plan that carries a deductible of at least $1,150 for an individual or $2,300 for a family in 2009. Since high-deductible health insurance plans carry lower monthly premiums, it leaves more money for the insured person to save toward future medical needs with an HSA. Those who do not have a high-deductible health insurance plan or are on Medicare are not eligible for an HSA, while those who are unemployed can have an HSA as long as they have income from savings investments and other sources to pay for their high-deductible health insurance and to make deposits to the HSA.

Benefits of HSAs

One of the main benefits of HSAs is that they can be fed with pretax money from an employer or an employee, similar to a 401k plan. This means that for every dollar one contributes to her HSA, she essentially saves a percentage equal to her income tax rate. Another advantage of HSAs is that account balances need not be spent at any particular time, so accounts can roll over from one year to the next if they are not needed. If one happens to be healthy for a long period of time, yet makes constant contributions to his HSA, it is possible to build up a large savings reserve that can cover all but catastrophic medical expenses, which then fall to the high-deductible health plan to cover.

Deposits and Withdrawals

Deposits can be made to an HSA by an employee, employer or a third party on the policy holder's behalf. The main restriction on deposits is an annual contribution limit that is set at $3,000 for an individual and $5,950 for a family in 2009. Withdrawals from HSAs can be made whenever the policy holder pleases, without requiring any notification to an outside party. In fact, some HSAs come with checks or cards that can be used to access funds from the account. In contrast to 401k plans, in which the owner must pay income tax when funds are finally withdrawn, funds used from HSAs toward qualifying medical expenses are not subject to income tax, even though the account is funded with pretax dollars. The tax advantages and growth potential of HSAs are meant to make consumers treat medical expenses more like a market than a necessity. Under standard health care, people may overuse health facilities, especially if they've already paid their deductible. When the individual is essentially spending her own savings every time she uses health care as she is under an HSA, she will tend to be more judicious about receiving medical care.