Consumers need to weigh benefits, drawbacks of HSAs

The new law makes HSAs permanent and available to everyone—individuals, professionals, and employees.

Speaking at a retreat for physicians last year, Glen A. Reed, a health law attorney with King & Spalding, LLP, Atlanta, had a difficult time making it through his presentation on the 2003 Medicare reform legislation. His audience kept interrupting him to ask about a provision of the law that created something called health savings accounts (HSAs), a new tax-advantaged way for consumers to set aside money for health-care costs.

"They interrupted us with their questions because they immediately latched onto the tax issues," said Reed, quoted in American Medical News.

The physicians in that audience were interested in not only what HSAs could do for their own families, but also how they might benefit their employees.

As double-digit increases in health-care premiums are becoming the norm, doctors and patients alike are fighting what sometimes looks like a losing battle against rising health-care costs.

While this problem is not likely to disappear entirely, the HSA legislation signed into law by President Bush a little more than a year ago offers nearly everyone the possibility of making a dramatic reduction in health-care costs.

In their first year on the market, HSAs attracted thousands of individuals and business owners. Now, about 1.5 million people are enrolled in HSAs. William Boyles, publisher of an industry newsletter, predicts that 20 million people will be enrolled within 5 years.

The new law makes HSAs permanent and available to everyone-individuals, professionals, and employees. They should not be confused with their predecessor, the flexible savings account. HSAs are the next generation of tax-favored medical insurance.

How HSAs work

HSAs come in two parts. First, you must buy a low-premium, high-deductible health insurance policy available through a growing number of providers, including such giants as Aetna, UnitedHealth Group, Blue Cross, Humana, and Golden Rule Insurance.

In conjunction with the insurance policy, you open a dedicated savings account in which you make tax-deductible deposits to pay for your medical care. Each year, you may deposit up to the amount of your policy's deductible and then use the money to pay for your medical care. Once your expense reaches the amount of your deductible, the insurance policy kicks in.

Consider this example: a patient enrolls her family in a plan with a $5,250 deductible policy and deposits $400 tax-deductible per month into her HSA. That year, her family's out-of-pocket medical expense, paid from funds in her HSA, comes to $3,200. Since her total deposits for the year were $4,800, the balance of $1,600 rolls over in the account. It compounds tax-free, as long as it is used to pay for qualified medical expenses.

As the money in the account grows, it becomes a resource available to cover the cost of routine or future medical care. This important feature makes HSAs far more attractive than their predecessors.

In another example, a man enrolls in a similar plan with the same deductible and also deposits $400 per month in his HSA. However, one of his children needs expensive surgery, raising the family's total medical expense for the year to $15,500. Once his out-of-pocket expense reached the family deductible of $5,250, the insurance paid the balance of $10,250. In this case, the HSA protected the family against a catastrophic medical expense.

Of course, the same tax advantages of HSAs are available to physicians and their families.

In addition to their tax incentives, HSAs offer control over the choice of doctors and eliminate the referral requirements of some health plans that many patients found objectionable. Money that accumulates in a tax-free HSA is immediately available when you need it to pay for medical care.

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