A better way to pay for healthcare

It's rare when a government program actually earns heaps of praise from a taxpayer. But when Health Savings Accounts were included in the Medicare Act of 2003, it was exactly what Dave Limberg of Bloomington, Minn., was looking for.

Not only have HSAs reduced healthcare costs for Mr. Limberg's family, the accounts have also kept a lid on costs at Standard Dynamics, a printing equipment distributor with nine employees, where Limberg serves as the company's controller.

"It was a no-brainer for us," says Limberg, who personally pays $490 every month for his wife's three prescriptions. "We had 17 percent increases in premiums over the past five years. Since we implemented HSAs, our overall healthcare costs have remained flat, compared with a 10.2 percent increase had we stuck with our previous plan."

In fact, HSAs are the latest method for controlling healthcare costs and represent a kind of 401(k) for healthcare expenses. Since the beginning of the year, the accounts have been available to people under age 65 who have a qualifying health-insurance plan with a deductible of at least $1,000 for individual coverage and $2,000 for family coverage. Individuals can dip into their plans to cover out-of-pocket healthcare costs up to $5,000 a year ($10,000 a year for families).

But what makes HSAs attractive to so many is that money in the accounts can be spent tax-free on healthcare, and the funding can be provided by companies, their employees, or both. Whoever provides them, annual contributions are limited to $2,600 for individuals and $5,150 for families.

If this sounds a lot like a medical savings account or a flexible savings account, it is - with one major difference. HSAs are far more flexible. For example, unlike MSAs and FSAs, which have been around since 1996, HSA money that goes unspent in any given year can be rolled over to future years. What's more, these accounts are portable, so when you change jobs, you can take the money with you. And if your employer doesn't offer an HSA, you can set up one on your own. Under the new law, an existing medical savings account can be converted to an HSA.

The program is so new that investment options aren't yet available. But eventually, experts say, money sitting in an HSA could be plowed into a money market or stock fund and earn money - much like an individual retirement account (IRA).

"If your company has this option, it makes a lot of sense to enroll in one," says Gary Ambrose, a financial planner in New York City. "Even for someone who's self-employed, there is no downside in implementing a plan of your own. It may be new, but there are some advantages taxwise to having an HSA."

Financial planners like just about any federal law that allows their clients to reduce their tax burden. With an HSA, earnings on your contributions to the savings accounts grow tax-free.

In addition, you can spend the money that accumulates on healthcare expenses now, or save it for the future. Withdrawals are tax-free forever, as long as you use the money to pay for medical care.

After age 65, you can use the money in an HSA for any purpose. If you withdraw money from the account for nonmedical expenses before age 65, you would then have to pay ordinary income tax on the withdrawal just as you would with an IRA. You would also be hit with a nondeductible 10 percent penalty.

"The flexibility regarding contributions and withdrawals makes these new accounts a nice backdoor IRA for people who make too much to contribute to a traditional IRA," says Joel Ticknor, a certified financial planner in Reston, Va.

Financial planners aren't the only ones praising HSAs. Physicians like Michael Carson, an obstetric internist at St. Peter's University Hospital in New Brunswick, N.J., also see the accounts as a good way for people with chronic illnesses to reduce their out-of-pocket expenses. Besides medication, qualifying medical expenses also include eye care, eyeglasses, contacts, hearing aids, laboratory expenses, Medicare premiums, nursing-home costs, long-term-care insurance premiums, X-rays, and physical therapy.

"We're seeing an increasing number of patients who have HSAs," says Dr. Carson. "Given the steady increases in healthcare costs, that's not that surprising."

The evidence is not just anecdotal. According to a just-released survey, nearly three-quarters (73 percent) of employers asked by Mercer Human Resource Consulting said they were likely to offer the new accounts to their workers by 2006. A similar survey conducted last year by the National Small Business Association found nearly identical results. The government will offer HSAs as a health insurance option to federal employees and retirees next year.

Despite the growing popularity of HSAs, the accounts have had their share of critics. The main criticism is that the accounts will benefit mainly the rich and could ultimately leave workers paying the majority of their own health costs.

"HSAs will siphon off healthy employees and leave traditional plans with less healthy or older workers," says Dan Adcock, assistant legislative director of the National Association of Retired Federal Employees. "That in turn will drive up premiums and do damage to the concept of group health insurance, which charges everyone on that plan the same premiums regardless of age or health."

Policy differences aside, HSAs represent another step in the shift to so-called "consumer-driven" healthcare plans, which aim to transfer responsibility for managing costs to healthcare consumers themselves.

The bottom line, according to financial planners, is that you should consider an HSA if you're interested in building a nest egg to cover future healthcare costs or if you're willing to exchange lower premiums for higher deductibles.

"HSAs are like an IRA on steroids," says John Goodman, the president of the National Center for Policy Analysis, who has been called "the father of medical savings accounts" by former House Ways & Means Chairman Bill Archer. "They are also another way to sock money away, especially when we don't know what will happen with the Social Security and Medicare systems in the future."