Recently, I was treated to one of life's unpleasant surprises - a letter from the service company managing my "retirement" plan, telling me that the cost of my health insurance premium next year would be more than double what I paid last year. Now, the premium wasn't exactly cheap to begin with, but this is ridiculous; and I don't need to be a rocket scientist to figure out that the cost of my health insurance is just going to keep getting worse, as we baby boomers start moving through the last stages of our lives.

Forget the long term political issue of how we're going to fund Medicare; this is a problem that affects me and it's going to affect you, as well. Using a Health Savings Account (HSA) to fund your medical expenses may not be the best approach for everyone - but, everyone should at least consider using one. The availability and cost of health care is always listed as the number one problem that small businesses have today. An HSA can be used by an individual operating as an independent contractor to cover personal health care needs, or by a small business to provide at least some health coverage for its employees. So, this will highlight how HSA's work and touch on an example of how the math might benefit you.

Health Savings Accounts are similar in many ways to 401k's and IRA's - they allow you to set aside funds on a tax deferred basis, have a few restrictions on how they can be used, and must be administered by an IRS approved trustee (usually a bank, insurance company, mutual fund, etc.). They must be used in combination with a High Deductible Health Plan (HDHP); generally speaking, the money you sock away in an HSA is first used to fund your medical expenses, with the HDHP kicking in to cover medical expenses above the high deductible threshold.

Here are some specifics. As mentioned above, you must first purchase an HDHP, with a minimum deductible of at least $1,050 ($2,100 for a family) and a maximum deductible of $5,250 ($10,500 for a family). The purpose, obviously, is to make certain that a safety valve is in place to cover extraordinary medical costs in any single year and you won't be able to open the HSA without one. Then you set up the HSA with a financial institution, basically the same way that you would open an IRA. In 2006 you can contribute the lesser of the amount of the deductible on your HDHP, or $2,700 for an individual, $5450 for a family; these amounts are tax deferred - you can deduct the contributions from taxable income on your return. So, here's the first benefit - the government is now paying a portion of your medical expenses.

You make withdrawals from the HSA to pay your medical expenses as you incur them. If those medical expenses exceed the deductible on your HDHP, it will then start picking up your medical expenses according to whatever provision you have in the policy. However, if you have funds left over in your HSA at the end of the year, they roll forward (remain in the account) and can be used in future years to cover medical expenses that you incur then. In other words, if your family had opened an HSA with $5,450 in year one and incurred only $3,000 in medical expenses during that year, $2,450 would remain in the account to be used in subsequent years (in addition to contributions in those years). This is the second benefit of an HSA - there is no "use it, or lose it" provision in these accounts; if you and your family are healthy, they provide a great means of building up a reserve against extraordinary medical expenses in the future. The third benefit of an HSA is that income earned in the account is also tax deferred