As health care costs continue to rise, consumers must find ways to ensure that they have the funds to pay for medical expenses not covered through their insurance. One way to save specifically for health care costs is to fund a health savings account (HSA).

Health Savings Account Basics

HSAs are tax-advantaged savings accounts set up in conjunction with high-deductible health insurance policies. Enrollees or their employers make tax-free contributions to an HSA and typically use the funds to pay for qualified medical care until they reach their policy’s deductible.

You are eligible for an HSA if you meet all four of the following qualifying criteria:

  1. You are enrolled in a qualified high-deductible health insurance plan (known as a “HDHP”).
  2. You are not covered by another health plan (whether insurance or an uninsured health plan).
  3. You are not eligible for Medicare benefits.
  4. You are not a dependent of another person for tax purposes.

There are maximum contribution limits that are adjusted annually. Contributions are made on a before-tax basis, meaning they reduce your taxable income. Unlike IRAs and certain other tax-deferred investment vehicles, no income limits apply to HSAs.

HSAs offer investment options that differ from plan to plan, depending upon the provider, and allow users to carry account balances over from year to year. Earnings on HSAs are not subject to income taxes.

Any medical, dental, or ordinary health care expense that would qualify as a tax-deductible item under IRS rules can be covered by an HSA. A doctor’s bill, dental procedure, and most prescriptions are examples of covered items. If funds are withdrawn for purposes other than qualifying health care expenses, you will be required to pay taxes on amounts withdrawn plus a 10 percent penalty.

HSAs are not for everyone. Check with your insurance company or employer to see how an HSA plan might differ from your current plan. To learn more about HSAs and if one would be a good fit for you, see IRS Publication 502 or talk with your personal financial planner.

Portions of this article were provided by the Financial Planners Association and Perspective Financial Services, a local FPA  member. © 2013 S&P Capital IQ Financial Communications. Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ Financial Communications nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information