Congress took note, and some years ago introduced a measure designed to give tax relief to those faced with that problem: the health savings account.

The health savings account, or HSA, allows you to defer taxes on any money you contribute, in order to cover out-of-pocket medical expenses. There is a catch, however: To qualify for an HSA, you must also own a qualified high-deductible health plan, or HDHP.

High-Deductible Health Plans Explained
HDHPs are major medical policies with higher deductibles than normally found in regular medical plans. These plans aren’t designed to provide full coverage for every little sniffle or stubbed toe. Instead, these plans are designed to keep premiums low by restricting coverage to major medical events. The consumer retains the risk of smaller, less severe or less expensive medical conditions.

HSA/HDHPs vs. Flexible Spending Accounts
You may be familiar with Flexible Spending Accounts. These plans – generally included in Section 125, or “cafeteria” employ benefits plans, also allow you to set aside money on a tax-advantaged basis to pay for medical expenses. However, with a Flexible Spending Account, you are under a “use it or lose it” restriction: If you don’t spend the money by the end of the year, the assets become the property of the employer.
HSAs, on the other hand, accumulate from year to year, compounding (hopefully, depending on your investment allocation within the account.

HSA and HDHP Eligibility
Not just anyone can contribute to an HSA. To be eligible, you must own a high-deductible health plan. You must also not be covered by any other health plan, nor enrolled in Medicare. Finally, you cannot be claimed as a dependent on someone else’s tax return. The IRS considers you eligible for an HSA all year long if you were eligible on December 1st of the previous year. However, a special “testing period” may apply if there are any changes in your eligibility status. We cover HSA eligibility in detail here.

Minimum and Maximum Deductible Levels
In order to qualify to contribute to an HSA, your high deductible health plan must meet certain criteria. For policies covering only yourself, with no family coverage, the annual deductible must be at least $1,200, as of 2011. The maximum annual deductible and other out-of-pocket expenses cannot be more than $5,950. The max limit, however, doesn’t apply to expenses or deductions for out-of-network services if your plan uses a network, which is the rule with health maintenance organizations (HMOs) and preferred provider organizations (PPOs). The limits apply only to in-network charges.
For family coverage, the minimum annual deductible is $2,400 for individual plans, and $11,900 for family plans. Your state may impose more restrictive limits on HDHPs.

Preventive Care
In some cases, your HDHP may provide for some preventative care without applying a deductible. This may apply to tests, checkups, mammograms and diagnostic procedures ordered as follow-ups to routine examinations.

HSA Contribution Limits And Taxation
Congress sets limits on the amount you can contribute to an HSA in any given year. Under current law (late 2010, as this is written), the contribution limit for an HSA for 2012 is $3,100, and the limit for families is $6,250. Those aged 55 or over can contribute an additional $1,000 per year. Currently, the base contribution limits are indexed to inflation, but not the 55+ catch-up contribution limit. If you contribute too much, you will be liable for a 6 percent excise tax on the overage.

Contributions are tax deductible, and all growth in an HSA is tax-deferred. If you withdraw the money to pay for a bona fide medical expense, the amount withdrawn is tax free. However, any withdraws you make to pay non-qualified expenses, or for any other reason other than medical expenses, is taxable as ordinary income, and subject to a 10 percent penalty.

Caution: As of 2011, purchases of over-the-counter medications are no longer qualified medical expenses for HSA purchases. This is a change from 2010 and previous years.

You can only contribute cash to an HSA. You cannot contribute property, such as securities. But you can roll assets held in an HSA over into a new HSA, with no tax liability. There is no upper limit to rollovers – only to new HSA contributions. You can contribute for tax year 2011 until April 15th of the following year (though you can only contribute a maximum of $3,050 or $6,150 for 2011, depending on whether you are contributing as an individual or for a family.)

Claiming the Deduction
To claim a deduction for a health savings account contribution, fill out an IRS form 8889, Health Savings Accounts, and submit it to the IRS along with your personal income tax return. You must use a Form 1040 or, if you are a non-resident of the United States, a 1040NR to claim the deduction; you cannot claim the deduction if you file using a Form 1040-EZ or a 1040A.

For complete information on health savings accounts, see IRS Publication 969.

1. Choose a low-cost but high deductible plan.
Enroll for a high deductible HSA or health saving account insurance plan that works in combination with health saving accounts. Due to higher deductible, your premiums per month will become lower.

2. Enroll and open a HSA savings account.
As soon as your HSA plan is establish, you can now open your real savings account in any qualified financial institutions. HSA and IRA are the same. In HSA, deposits are tax-deductibles and the withdrawals are done in tax-free basis for paying medical expenses. Yearly limits are forced in the amount being contributed.

3. Supplemental retirement funds.
Overall, you must be capable in funding the account with extra dollars or else you will be paying a higher cost health plan. Plus, a family can save up to $1,600 every year in taxes by subsidizing their health savings account. Unused funds every year by year are being added and then accumulated in retirement base in tax-favor.

HSA Benefits at a Glance:
• Remarkable tax-savings – regardless of whether you itemize.
Filing your taxes yearly, your money that is deposited in your health account becomes tax-deductible on line 25 in front page of your form. This will give you deduction in your tax bill by a $2,000 for families that is based on 33% tax bracket. In tax savings, with HSA plan, we can say that you are using your money in paying your medical bills that otherwise can be used in paying your taxes.

• Double-discounts.
If you visit your physician, you can use your tax-free money from your health savings account in paying them, money that otherwise can be used in paying taxes or premiums. The accounts in HSA can be easily available by check or debit card. Your bill can be reduced in advance of payment if your provider is a member of PPO discount network.

• Rx savings.
When you buy prescriptions and medications, simply go to a PPO discount pharmacy and pay the amount that is discounted on the spot by check or debit card directly in your health savings account. For more savings, you can use the priced Rx mail service. Other plans are excluding Rx drugs from the coverage of premium savings.

• Tax-free money for dental, eye wear, etc.
Other medical expenses that are not covered by HAS insurance policy can still be considered as an allowable expenses in the health savings account. Examples, dental work that includes braces, vision care with glasses, and eye surgery and alternatives therapies like acupuncture can be all paid with tax-free cash from HSA.

• The Super-IRA effect.
Money that you don’t use each year on your health savings account is being add up to your account. It continuously grows and grows based on tax-sheltered. When you reach the age of 65, you can use your account just like a traditional IRA.

Tip: Continue funding your HAS account every year up to the maximum amount allowed every year. In paying routine medical bills you can use after tax dollars. This helps you reduce your taxes yearly and will allow you to make your account larger, which gives you a greater help in unexpected tragedy in the future and larger amount for your retirement. (Note: Using HSA account in paying your medical bills with tax-free dollars is not the same as paying them using your own money from your pockets-your HSA covers only for small bills and the unused amounts are you’re to keep. This is a stark contrast in paying an insurance firm a little thousand dollars yearly to do effectively the equal thing–insure the “small” bills).

1. In today’s world, your employer will often have these plans available.
When you receive an open-enrollment package, you will see new and unique benefits in the menu. Many companies are progressively proposing health insurance packages that include high-deductible policies and a tax-advantaged health savings account (HAS) that you can get cash in paying your medical and health bills.

According to Towers Watson, a human resources firm, a specific 45% of huge companies are offering the options that have increased 25% from 2007.
They offer lower premiums for individuals that is usually 10% to 40% less compared to those traditional plans.. Many employers like this plan because it provides them affordable benefits for their own wellness.

2. The Plans Can Be Affordable
You can save a lot on premiums compared to traditional plans but it has higher deductibles that is at least $1,200 per person and $2,400 per families. You can use up every dollar that you pay in your medical care. Cover the costs; you can set pre-tax money in one up to $3,050 for persons in 2011, $6,150 for families and additional $1,000 more if you are 55 or older. Your employer can contribute also. Withdrawing medical bills remain tax-free. Not used money from year to year is constantly increasing without being taxed.

3. They Make Sense For People Who Choose High Deductible Plans
Many people choose high-deductible plan because it can save them money. For example, people that are young and healthy can benefit better for the reason that they pay low premiums and they do not use much care.

Persons having a pricey medical condition like cancer can also get benefits. When you achieve the out-of-pocket maximum of your plan that is not more than $5,950 per person and $11,900 per family, then you pay nothing. Compare to traditional plans in which you will not ever stop owing co-pays. Read Health Savings Account Rules 2011 for up-to-date numbers.

4. Always crunch the numbers yourself before you enroll.
In this plans the deductibles and the coverage next to deductible varies widely. To make sure that enrolling in this plan is worth while do the calculating so you can check.
A calculator will be provided by your company to show you how you have fare in this plan versus other options that is based on previous year’s health costs. On the other hand if these don’t happen you must ask your insurer to breakdown your 2010 expenditures. And sum up all the payments you have on each plan. You should also pay attention on prescription costs. In some high-deductible plans don’t usually cover drugs and prescriptions.

5. When Setup Properly, Health Savings Accounts Can Also Be Used for Retirement
You can use HSA or health saving accounts to supplement your medical plans if you have enough cash in paying health bills. You can still use the funds tax-free for your medical needs even if you are in retirement. And at the age of 65, you may extract penalty-free for any purpose but you have to pay income taxes.

In investing you can choose how it will be done. However, if you want to save it for your retirement then choose low-cost mutual funds. But if you will use your money for present health and medical costs, saving account is the exact bet for it.

Individuals with Self Only Coverage:
In 2011 the limit on your annual deduction under section 223(b)(2)(A) with a high deductible health plan is $3,050

Individuals with Family Coverage:
In 2011 the limit on your annual deduction under section 223(b)(2)(A) with a high deductible health plan is $6,150

What defines a High deductible health plan?
To qualify for a High deductible health plan as stated in section 223(c)(2)(A), you must meet these two criteria:

1. Your health plan must have an annual deducible no less then $1,200 for individual coverage and no less the $2,400 for family coverage.
2. All expenses other than insurance premiums can not exceed $5,950 for individual coverage or $11,900 for family coverage. Examples of other expenses are things like co payments, deductible payments and any other out of pocket expenses.

It’s important to know that an individual can set up a Health Savings Account or an employer can add a Health Savings Account option to the so-called cafeteria benefit plan it may already offer.

The Health Savings Account is set up like an IRA and differs from a traditional savings account. A trustee approved by the IRS must be used. Money put in the plan grows tax free and funds withdrawn for qualified medical expenses are also tax free. Unlike the older Flexible Savings Accounts offered in employer cafeteria plans, you don’t have to spend the money put into the account by year end or otherwise lose whatever is left. Money can be rolled over from year to year. This can allow for a nice chunk of money to accumulate that can be withdrawn tax free at age 65.

If part of an employer plan, the money put into the plan is before taxes, including Social Security. Otherwise it is an above-the-line deduction, meaning you don’t have to itemize your deductions to get the tax break and the deduction is not subject to the phase-out rules that make many itemized deductions unavailable to high wage earners.

In order to qualify for a Health Savings Account, the individual or family must purchase a high deducible health insurance policy. These are special policies that have a minimum deductible of $1000 to a maximum of $5000 for an individual and $2000 to $10,000 for a family. The higher the deductible, the lower the premium.

Individuals can contribute and deduct the lesser of $2250 or the deductible on the policy: for married couples or families it is double that. If over 55, the contribution and deduction is $600 higher for individuals and $1200 higher for couples and will continue to rise at $100 a year until 2009, where it will be capped at $1000 for individuals and $2000 for families or couples.

The money in the Health Savings Account cannot be used to pay the premiums for this policy except in certain circumstances (basically when you’re unemployed). It is meant to meet the deductible on the policy, co-pays, drug costs, eyeglasses or any other medical expense that could be itemized on an individual tax return as a medical expense.

Money used to pay qualified medical costs is withdrawn tax free. Money withdrawn in excess of qualified medical expenses is taxed as income and subject to a 10% penalty, unless the owner is disabled or over 65. Any money in the account at death is added to the taxable estate.

There are no income limits on Health Savings Accounts. If started early, when you are still young and healthy, a substantial amount of money could accumulate to either meet higher medical costs as you get older or to use to supplement your income in retirement.