Investing for Your Health: Health Savings Accounts

Health care costs are growing at an unprecedented rate. In 2000, Americans spent nearly $1.3 trillion on health care. By 2010, health care costs are expected to double - to $2.6 trillion (or 15.9 percent of the U.S. Gross Domestic Product), according to the U.S. Department of Health and Human Services Centers for Medicare & Medicaid Services. Indeed, Institute research finds that 28 percent of 401(k) plan participants who took hardship withdrawals from their plan accounts did so to pay for medical emergencies.

U.S. Household Expenditures for Health Services and Supplies, 1993-2000
(billions of dollars)

Source: U.S. Department of Health and Human Services Centers for Medicare & Medicaid Services

Soaring heath care costs have captured headlines everywhere. Yet recent research indicates that fewer than half of all workers age 40 and older think much - if at all - about health insurance when planning for retirement. Escalating costs are not the only reason to factor health care into retirement planning. On average, spending to meet medical needs more than doubles after age 65. And more and more employers are dropping or cutting back on health coverage for retirees.

Pre- and Post-Retirement Medical Spending
(average health care costs per person, 1999)

Source: "Medical Expenditure Panel Survey," Agency for Healthcare Research and Quality (latest data available)

There is some good news. Recent legislation may make the prospect of meeting future medical expenses less daunting. The legislation creates incentives to save through Health Savings Accounts (HSAs). HSAs became available on January 1, 2004.

This brochure summarizes HSA eligibility requirements, contribution limits, and covered medical expenses.

What is a Health Savings Account (HSA)?

A Health Savings Account (HSA) is a plan that allows workers with high-deductible health insurance coverage to set aside money each year for routine or future health care costs. HSAs provide a number of unique benefits to eligible contributors, including:

tax-deductible contributions,
tax-free earnings,
tax-free distributions, and
enhanced portability, allowing beneficiaries to take assets from job to job and into retirement.

An important caveat is that HSAs are established exclusively for the purpose of paying the qualified medical expenses of the account beneficiary. Also, for the months in which contributions are made to an HSA, the beneficiary must be covered under a high-deductible health insurance plan.

What are the health savings benefits of using an HSA?
You can use an HSA to make annual contributions to cover current or future health care costs. Because any money you don't spend remains in the HSA from one year to the next and travels with you from one job to another, HSAs also offer a long-term advantage. If you're relatively healthy during your working years, by the time you retire, you'll have a good head start on those growing retiree medical expenses. And since the money belongs to you, no matter when you spend it, you can choose any doctor or hospital you like without the need for referrals or pre-approvals.

What are the tax advantages of contributing to an HSA?

Contributions to HSAs are made on a tax-deductible basis, meaning you can deduct them from your gross taxable income. You can invest contributed amounts as you choose, and those investment earnings accumulate tax-free until you need the money. Once you decide to make a withdrawal, that's tax-free, too. Of course, the funds must be used to pay for qualified medical expenses, including health insurance deductibles and any co-payments for medical services, prescriptions, over-the-counter drugs, and dental and vision care. Tax-free distributions are also allowed for health care needs not covered by the beneficiary's insurance policy, continuation coverage required by Federal law (i.e., COBRA), health insurance for the unemployed, and long-term care insurance.

Who can open an HSA?
Any American worker (not entitled to Medicare benefits) is eligible to open an HSA if he or she is under age 65 and enrolled in a qualified health plan. Qualified health plans include those with:

a deductible of at least $1,000 and a cap of no more than $5,100 on out-of-pocket expenses for individuals, and
a deductible of at least $2,000 and a cap of no more than $10,200 on out-of-pocket expenses for families.

Who can make an HSA contribution?
Contributions may be made to an HSA by individuals, their employers, and family members. Contributions made by eligible individuals or by family members on their behalf are tax-deductible, even if the account beneficiary does not itemize deductions.

HSA contributions made by an employer are tax-deductible for the employer and may be excluded from the employee's gross income.

	Guidelines for Health Savings Accounts (HSAs)
Qualified Health Plan: Minimum Deductible	Individual Coverage: $1,000 ($1,050 in 2006) Family Coverage: $2,000 (one deductible for all family members covered by health plan) ($2,100 in 2006)
Qualified Health Plan: Maximum Out-of-Pocket Expenses	Individual Coverage: $5,100 ($5,250 in 2006) Family Coverage: $10,200 (one total for all family members covered by health plan) ($10,500 in 2006)
2005 Maximum Annual Tax-Deductible Contribution to Health Savings Account	Individual: the lesser of 100 percent of deductible or $2,650 ($2,700 in 2006) Family: the lesser of 100 percent of deductible or $5,250 ($5,450 in 2006) Individuals between the ages of 55 and 65 may make a catch-up contribution of up to $600 in 2005 ($700 in 2006). The "catch-up" contribution amount increases annually until it reaches $1,000 in 2009.
Services Not Subject to the Deductible	Preventive care services, as well as coverage for accidents, disability, dental care, and vision care.
Tax-Free Withdrawals Allowed for:	Medical expenses, including: health insurance deductibles, co-payments for medical services, prescriptions, over-the-counter drugs, chiropractic, dental, vision, "alternative" therapies such as acupuncture, and other traditional in- and out-patient medical expenses; COBRA premiums; Health care premiums paid while an individual is receiving unemployment compensation; and Long-term care insurance premiums.
Penalty for With- drawals Not Used for Medical Expenses	Prior to Age 65: Withdrawals are subject to ordinary income tax and a 10 percent penalty. Over Age 65: Withdrawals are reported as ordinary income.

What are the HSA contribution limits?
Eligible individuals may contribute up to 100 percent of their qualified health plan deductible to their HSA on a tax-deductible basis. The maximum annual contribution is $2,650 for individual policies and $5,250 for family policies.

Individuals (and their spouses covered under the high-deductible health plan) ages 55 to 65 may make additional "catch-up" tax-deductible contributions to their HSAs to help build a nest egg to save for medical needs in retirement. In 2005, these individuals may make "catch-up" contributions of up to $600. The "catch-up" contribution amount increases annually until it reaches $1,000 in 2009.

How can amounts in an HSA be invested?
Contributions to HSAs may be invested in fixed accounts, mutual funds, stocks, or bonds.

Are rollover contributions to HSAs permitted?
Rollover contributions may be made from Archer Medical Savings Accounts (MSAs) and other HSAs only. Rollovers are not subject to the annual contribution limits.

Are HSA assets portable?
Yes. The designated beneficiary of an HSA owns the account. The account assets follow the individual from job to job and into retirement. If the beneficiary dies, ownership of an HSA may be transferred to the beneficiary's spouse on a tax-free basis.

How are HSA distributions treated?
The money you withdraw from an HSA, as long as it's used for medical expenses, is not taxed. Distributions made for any purpose other than qualified health care expenses are subject to income tax and a 10 percent penalty. The penalty is waived in the case of death or disability and for distributions made to individuals age 65 and older.

How do HSAs differ from Flexible Spending Arrangements?

Flexible Spending Arrangements (FSAs) are employer-sponsored benefit programs under which employees may make tax-deductible contributions. Funds in the FSA may be used to reimburse the employee for certain medical expenses. Unlike HSAs, there is no statutory limit to the amount of contributions that may be made to an FSA (although employers may impose limits). However, any unused amounts in an FSA at the end of the year are forfeited - you "use it or lose it." In contrast, an HSA continues to grow in your account year after year until you need it.

Where can I get more information?

In addition, a section of this website includes detailed information about the benefits of setting long-term investing goals, such as saving for retirement and education.