Health insurance 101: Health savings accounts help consumers fill gaps in coverage

[Fifth in a series of blog posts to help you better understand health insurance and how recent changes affect you]

As we’ve noted throughout this series, consumers are shouldering more responsibility for their own health care spending. New consumer-directed health plans incorporate tools to ease the burden and help individuals make smarter decisions regarding their care. One way is through health savings accounts.

An HSA allows you to pay for current health care expenses not covered by your high-deductible health plan and save for future ones, all on a tax-free basis. The account is funded by the employee, the employer, or both, but the account is owned by the employee. Leftover balances can be rolled over from year to year.

Pairing an HSA with a high-deductible health plan, which generally doesn’t cover the first several thousand dollars of your health care expenses, can be a smart way to go for some. Withdrawals are tax-exempt when used to pay for qualifying medical expenses, and contributions to an HSA reduce your taxable income.

Money used to pay for nonqualified expenses, however, is subject to a 10 percent tax penalty, an amount that rises to 20 percent after Dec. 31, 2010. A partial list of qualified medical expenses is available on Publication 502 at irs.gov.

When you set up an HSA, you determine your annual contribution. You can estimate these needs by:

• Reviewing your eligible expenses from the previous year
• Determining how your upcoming expenses may differ from the previous year

For 2010, your contribution cannot exceed the maximum of $3,050 for individual coverage or $6,150 for family coverage. A variety of other rules apply, but money not used during the year rolls over to the next year and can earn interest tax-free. You can also place your unused funds in a longer-term investment through the bank that administers your HSA.

You can contribute money directly, through deductions from your tax return, or via withdrawals from your 401(k) or other retirement plan. Employer contributions are not subjected to payroll taxes.

The use of health savings accounts has risen dramatically since being introduced in 2004. The ranks of Americans who supplement their health plans with HSAs was expected to rise as high as 45 million by 2010, from 438,000 in late 2004.

Next week: A glossary of health insurance terms

Health insurance 101: The rise of consumer-directed health care plans

Third in a series of blog posts featuring frequently asked questions about health insurance.

As we discussed in last week’s post, employers are passing more of the costs of health coverage to employees. In response, insurers are offering health plans that help individuals better absorb expenses and use their health care dollars more wisely.

What is meant by consumer-directed health care?