The Pros and Cons of the Health Savings Account

Health savings accounts (HSAs) are used to save money for future medical expenses. Discover how these plans work and whether or not they are right for you.

A health savings account (HSA) is an account into which you can deposit tax-free money to be used for future medical expenses. HSAs were established in 2003 and have rapidly risen in popularity. They are part of a larger trend known as consumer-directed health care. The aim of consumer-directed healthcare is to reduce the money spent on health care by placing more of the responsibility on you to shop for health care. Want to spend less on hospital visits - smoke less, eat healthier, and exercise. Because the days of your employer footing the bill are no more!

Account Advantages

The HSA is equipped with several advantages, many in the form of Uncle Sam's generous tax benefits. Contributions to the plans are tax deductible. The contributions can come from you, as well as your employer, if you have an HSA through work. Individuals age 55 and older can make additional catch-up contributions to the account each year until they enroll in Medicare.

All HSA earnings are tax-free, and there is no limit to how much you can accumulate in the account. When you take money out to pay eligible medical costs, those distributions are tax- free, too. But perhaps the most appealing part of an HSA is that there are no time constraints on when you can spend it. If you don’t use all the account money on healthcare costs, you don’t lose it. You can carry any money that’s in the account at year’s end over into the next year to pay for future medical costs.

One Plan, Two Components

The first consideration when it comes to HSA participation is the required companion healthcare policy. Although the potential for HSA participation was opened up a few years ago, you must have a specific type of coverage.

The first criterion in any situation is that you have a high-deductible health plan. These are just like they sound; the insured policy holder will initially pay greater out-of-pocket costs.

Eligible plans are available through various insurance companies; however, they all have deductibles for 2009 of at least $1,150 but no more than $5,800 for singles and between $2,300 and $11,600 for covered families. If your healthcare costs reach the deductible level, the policy coverage kicks in.

Once you get your insurance policy, then you can open your health savings account. Currently, an individual can put up to $3,000 a year in an HSA. An account for family coverage can be as much as $5,950. HSA contributions often come from savings by paying the typically lower premiums charged for the accompa- nying high-deductible policy. Then, when you have to meet some deductible costs, you use HSA money to pay. The deductible part is pure insurance costs and healthcare costs. The side fund, the HSA, is a sep- arate entity, an actual savings account. You have the opportunity to put money aside for those emergencies when you do need to meet the deductible.

While a high-deductible insurance policy and HSA works well for many, it’s not a good fit for everyone. Some folks find that a traditional employer- provided plan, while it generally costs more in up-front payments, is more cost-effective over the longer term. In any traditional health plan, you will have an office visit and prescription co-pays, but that’s not the case with an HSA. There is no office visit or prescription co-pay.

There are a lot of cases, such as young families making really good money, who would appreciate the tax advantages of HSAs but have small children that will have to go the doctor three or four times a year for shots, checkups and illnesses picked up at day care. In those cases, more traditional healthcare coverage is the better financial and medical choice. But for individuals or families who are in good health, HSA-eligible cover- age could be a better prescription. An HSA is particularly good if you’re rea- sonably healthy, in a higher tax bracket and your kids are older and don’t need regular checkups. Then you can really take advantage of the tax benefits of an HSA.

For the fifth week in a row, Southern Community bank has the best savings rate on the BestCashCow rate tables, paying 2% APY on savings deposits via its Ready Saver program. That's 60 basis points higher than the BestCashCow savings rate average which remained steady this week at 1.39% APY (BestCashCow tracks the 30 highest savings rates in the US). What's nice about Ready Saver is that it has a relatively low minimum balance of $1,500.

Everbank continues to offer their promo rate of 2.25% APY for the first three months on new money. After three months, the rate drops to 1.26% APY for a 1-year blended APY of 1.51%. Franklin Synergy rounds out the top with a 1.75% APY savings rate with a minimum balance of $25,000.

The savings rate average remained steady because there were not increases or decreases in rates on the BestCashCow savings and money market rate table. Banks seem to have taken a wait-and-see approach to what will happen to interest rates and the economy. In the most recent FOMC meeting two weeks ago, Bernanke made it clear that rates will stay low for a good deal longer. Despite that, many economists, inculding former Fed Chairman Alan Greenspan believe it is just a matter of time before massive deficit spending sends interest rates higher. Until the unemployment rate shows some decline though, it's hard to see rates moving up much. The Fed has a dual mandate of low inflation and maximum employment. Right now it has the low inflation but unemployment stands near 10%.

The worst of the declines in savings rates seem to be over althought it's not inconceivable we'll see average ratings hitting 1% APY in the next couple of months if the rate outlook doesn't change. That means the top rate will be somewhere near 1.5% APY. The slow drift down continues.