First, let's look at the insurance part of it.
At its most basic level, a Health Savings Account 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 $2,400
Maximum is $3,200
20% (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% $2,400
20% until total= $3,200 $ 800
Total out of your pocket $3,200
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 preventative benefits which are handled separately so make sure to read the full plan brochure. If you really want a great introduction to medical insurance, start here first, otherwise let's look at the exciting half...the Health Savings Account.
Now let's look at the exciting part for self-employed and small business...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% (up to certain limits) 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 administrator with the best options is MSABank or FirstMSA. 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% of a year's deductible...year after year. This money is separate from the premium you pay each month to keep your medical 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 combined with a tax-favored Savings account
-fund with pre-tax dollars
-accrue interest tax-deferred
-pay out medical bills tax-free