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  Health Saving Accounts - How it Works

The HSA actually has two components:

1)  High deductible 2)   Tax-favored   
     Insurance Plan      Savings Account

First, let's look at the insurance part of it.

At its most basic level, an HSA includes a high deductible plan.  You pay a monthly premium like any insurance plan to keep this protection in force.  Note that the premium is usually much cheaper than other plans.  

A deductible means that in a calendar year for covered expenses, you are responsible for 100% of the deductible amount before the company begins to pay.  The other important piece is the Maximum out-of-pocket which refers to when the insurance company then begins to pay 100% (we are talking about catastrophic care here).  Usually between the Deductible and the Maximum, you are paying a percentage.

Let's look at an example...

 Medical expense relating to surgery:   $30,000

    Insurance Deductible is $2,500
    Maximum is $3,300
    30% (of medical expenses) after deductible until you have
    met another $800 (up to your max) out of your pocket

In this case, providing you are in network for covered benefits, you would pay:

    Deductible at 100%              $2,500
    30% until total= $3,300           $800
    Total out of your pocket        $3,300

Now keep in mind that if you stay in the network, you will receive negotiated rates, usually a 30-60% discount.  To understand why, you can check out our other section, 101.  Now, with most HSA plans, the deductible is all inclusive - hospital, doctor, prescription etc.. There are certain benefits which are handled separately so make sure to read the full plan brochure.  If you really want a great introduction to health insurance, start here first, otherwise let's look at the exciting half...the medical savings account. 

Now let's look at the exciting part for...the HSA savings account.

By the book, Health Savings Accounts are tax-favored accounts set up to pay for certain medical expenses and to allow for the build-up of savings to pay for future medical expenses.  Accounts are set up with banks and certain other qualified financial institutions.

Let's dig a little deeper...

You are allowed to fund this account with up to 100% (deductible is doubled for 2 or more people on one policy i.e. family) of your plan's annual deductible (pro-rated for less than a year) with pre-tax dollars.  This account is set up at a separate institution than the insurance company.  The largest administrators with the best options are FirstMSA and MSABank.  Go here to get more information if you already have the insurance set up or want to investigate further.  

Money not used rolls over year to year.  In fact, it earns interest tax-deferred.  Past a certain limit, you can also choose to invest the excess depending on the bank or institution you choose to go with.  You can continue to add up to 100% (up to certain limits) of a year's deductible...year after year.  This money is separate from the premium you pay each month to keep your health insurance in place.  You own this money just like an IRA or savings account.  This is the first part...funding and growing pre-tax.  

The second part is where this plans actually surpasses an IRA...

For certain medical, dental, and long-term care expenses, payments made from your established and funded account is not taxed or penalized.  At 65 you are able to withdraw this money penalty-free but subject to income tax.  If you withdraw the money for non-eligible expenses before the age of 65, it will be subject to a 15% penalty and income tax.  

So to sum it up...

High deductible insurance plan    
HSA Savings account
  -fund with pre-tax dollars 
  -accrue interest tax-deferred
  -pay out medical bills tax-free

Now let's check out the
monthly premium rates which are much cheaper than standard plans.

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