'Mellody's Mail': Health Savings Accounts

Q U E S T I O N: My daughter, age 26, is a self-employed small business owner. She is married and has two young children. She would like your recommendation on Health Savings Accounts — are these plans a good way to go for the self-employed? She has a major medical plan already; however, I do not know what the deductible is on this plan. The family is in good health.

A N S W E R: Given the escalating costs of health care, your question about Health Savings Accounts (HSAs) is an excellent one. Created in December of 2003 as part of the Medicare-prescription drug legislation, HSAs are special accounts which allow you to build a tax-free nest egg to cover a wide of range of qualified medical expenses, including the cost of prescription drugs, nursing homes, physical therapy, eyeglasses and contact lenses. Accounts can be set up through a health insurance plan as well as through financial institutions that include banks, brokerage firms and mutual fund companies.

To qualify for an HSA, you must have a single health-care plan with an annual deductible of at least $2,000 for a family and $1,000 for an individual (by most comparisons, these deductible levels are quite high). On an annual basis, you can contribute the lesser of your deductible or $5,150 for a family and $2,600 for an individual.

This means if your deductible is $3,000 for your family, you can contribute only $3,000. Contributions can be made by an individual, their employer or both. Although your daughter is too young to take advantage of "catch-up" contributions, those aged 55 to 65 years old can contribute an additional $500 to their HSAs in 2004.

One of the biggest benefits of an HSA is that contributions, investment gains and withdrawals are all tax-free, provided the money is used for qualified medical expenses. Additionally, unlike a flexible spending account, you do not forfeit your contributions if you have not used them by year-end. Rather, any unused money is rolled over to the next year. Once you reach age 65, you can use the money you have accumulated for both medical and non-medical expenses without penalty.